-----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, U+/NffI/92l5AG6dmfjVcRLiNDRek0YwIAkegiCr3jOfMA1tHEYIzfN78GiioamI i+H11FaFdCIGCsIR2U9/zA== 0001095811-00-000452.txt : 20000307 0001095811-00-000452.hdr.sgml : 20000307 ACCESSION NUMBER: 0001095811-00-000452 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 20000306 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: 333-30816 FILM NUMBER: 561543 BUSINESS ADDRESS: STREET 1: 8001 IRVINE CENTER DRIVE CITY: IRVINE STATE: CA ZIP: 92618 MAIL ADDRESS: STREET 1: 8001 IRVINE CENTER DRIVE CITY: IRVINE STATE: CA ZIP: 92618 S-1/A 1 AMENDMENT NO. 2 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 6, 2000 REGISTRATION NO. 333-30816 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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)
8001 IRVINE CENTER DRIVE IRVINE, CA 92618 (949) 754-8000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ MR. VINCENT C. SMITH CHIEF EXECUTIVE OFFICER QUEST SOFTWARE, INC. 8001 IRVINE CENTER DRIVE IRVINE, CA 92618 (949) 754-8000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: LAURA B. HUNTER, ESQ. ALAN K. AUSTIN, ESQ. CHRISTINE P. LE, ESQ. BRIAN C. ERB, ESQ. BROBECK, PHLEGER & HARRISON LLP BRIAN M. MCDANIEL, ESQ. 38 TECHNOLOGY DRIVE WILSON SONSINI GOODRICH & ROSATI IRVINE, CALIFORNIA 92618 PROFESSIONAL CORPORATION (949) 790-6300 650 PAGE MILL ROAD PALO ALTO, CALIFORNIA 94304 (650) 493-9300
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. ------------------------ If the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the "Securities Act"), check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE(2) - -------------------------------------------------------------------------------------------------------------------- Common stock, no par value.................................. $569,940,000 $150,464.16(3) - -------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------
(1) Includes 630,000 shares which the Underwriters have the option to purchase from certain selling shareholders and/or the Company to cover over-allotments, if any. (2) Estimated solely for the purpose of computing the registration fee pursuant to Rule 457(c) of the Securities Act of 1933, as amended, and based upon the average high and low prices on March 2, 2000, as reported on the Nasdaq National Market. (3) $129,136 previously paid. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY CHANGE. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES, AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED MARCH 6, 2000 [QUEST SOFTWARE LOGO] 4,200,000 SHARES COMMON STOCK ---------------------------------- Quest Software, Inc. is offering 1,904,230 shares of common stock. The selling shareholders identified in this prospectus are offering an additional 2,295,770 shares. We will not receive any proceeds from the shares of common stock sold by the selling shareholders. Our common stock is traded on the Nasdaq National Market under the symbol "QSFT." On March 2, 2000, the last reported sale price for our common stock on the Nasdaq National Market was $118.00 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............................. $ $ Proceeds to selling shareholders............................ $ $
---------------------------------- THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE NOT APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. We have granted the underwriters a 30-day option to purchase from certain selling shareholders and/or us up to an additional 630,000 shares of common stock to cover any over-allotments. FleetBoston Robertson Stephens Inc. expects to deliver the shares of common stock to purchasers on . ---------------------------------- ROBERTSON STEPHENS CHASE H&Q DONALDSON, LUFKIN & JENRETTE CIBC WORLD MARKETS WIT SOUNDVIEW FAC/EQUITIES THE DATE OF THIS PROSPECTUS IS MARCH , 2000. 3 Inside Front Cover [QUEST SOFTWARE LOGO] The Quest Solution. Quest offers both application and information availability solutions that enhance the performance and reliability of e-business, enterprise and custom applications and facilitate the delivery of information across the entire enterprise. [Schematic depiction of enterprise software environment showing the functionality of and relationships among Quest's products and this underlying environment.] [Three columns of text at the bottom of the page. The first column is entitled "Development -- Deployment" and reads, "Integrated products that aid in the rapid development, testing and automated deployment of Internet software applications in quickly changing, mission-critical environments." The second column is entitled "Production Management" and reads, "Software solutions designed to maintain high performance and provide constant access to critical business applications, as well as monitoring these systems to detect and correct problems before they impact users." The third column is entitled "Information Delivery" and reads, "An output management system that captures and delivers reports and data from nearly any software application for immediate and secure distribution to information consumers within an organization or over the Internet."] 2 4 YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. ------------------------ TABLE OF CONTENTS
PAGE ---- Summary..................................................... 4 Risk Factors................................................ 7 Information Regarding Forward-Looking Statements............ 15 Use of Proceeds............................................. 16 Dividend Policy............................................. 16 Price Range of Common Stock................................. 16 Capitalization.............................................. 17 Selected Consolidated Financial Data........................ 18 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 19 Business.................................................... 28 Management.................................................. 42 Certain Transactions........................................ 51 Principal and Selling Shareholders.......................... 53 Description of Capital Stock................................ 56 Shares Eligible for Future Sale............................. 58 Underwriting................................................ 60 Legal Matters............................................... 62 Experts..................................................... 62 Additional Information...................................... 62 Index to Financial Statements............................... F-1
3 5 SUMMARY You should read the following summary together with the more detailed information and consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus. This prospectus contains forward looking statements that involve risks and uncertainties. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of the factors set forth under "Risk Factors" and elsewhere in this prospectus. QUEST SOFTWARE, INC. We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Organizations are constantly seeking ways to use information and technology to compete more effectively. Today, organizations must deliver relevant information and provide increasingly sophisticated and time-sensitive services to a rapidly expanding audience, including employees, customers, suppliers and partners both inside and outside the traditional enterprise. Many organizations are beginning to extend their business over the Internet to directly reach a large number of geographically dispersed end-users. These initiatives, commonly referred to as e-business, are raising the strategic importance of real-time information and are increasing the challenges of building and maintaining the systems to effectively manage and distribute information. As a result, organizations must assure that their systems provide: - Application availability -- uninterrupted and high performance access to applications under widely varying conditions; and - Information availability -- broad distribution of critical business information from underlying applications to decision-makers throughout the entire enterprise. We offer a family of products that provide both application and information availability solutions. Our products are designed to work individually and together to provide immediate and continuous availability of applications and information. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems by utilizing a number of integrated products that tune the performance and monitor the operation of applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database products that maintain a real-time copy of a database for offloading critical systems and assuring high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. The key elements of our strategy include extending our product leadership, continuing our focus on the e-business applications market, leveraging our significant installed base, expanding our sales force and international distribution channels and extending our existing strategic relationships and developing new partnerships with leading global systems integrators. We have thousands of customers across a range of industries including technology, financial services, manufacturing, healthcare, energy, insurance and telecommunications. We market and sell our software and services worldwide through a combination of direct sales and telesales in the United States, Canada, Australia, the United Kingdom and Germany, as well as through resellers and distributors. In August 1999, we completed an initial public offering of our common stock, raising net proceeds of approximately $64.9 million. In December 1999, we acquired MBR Technologies, Inc. In January 2000, we acquired Foglight Software, Inc. and in February 2000, we acquired QMaster Software Solutions, Inc. 4 6 THE OFFERING Common stock offered by Quest......... 1,904,230 shares Common stock offered by selling shareholders.......................... 2,295,770 shares Common stock to be outstanding after this offering......................... 40,809,574 shares Use of proceeds....................... We intend to use the net proceeds for general corporate purposes, including working capital, expanding our sales and marketing efforts, product development, expanding our customer support organization, possible acquisitions and capital expenditures. Nasdaq National Market symbol......... QSFT The number of shares of common stock to be outstanding after this offering is based on the actual number of shares outstanding as of December 31, 1999 which excludes: - 5,061,200 shares of common stock issuable upon exercise of stock options outstanding as of February 16, 2000, at a weighted average exercise price of $7.14 per share; - 190,974 shares of common stock issued upon the exercise of options in between January 1, 2000 and February 16, 2000; - 2,210,320 shares of common stock reserved for future issuance under our stock incentive plans; - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan, of which 119,097 shares were issued in February 2000. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and Note 8 of the notes to our consolidated financial statements; and - 1,187,603 shares of common stock issued in connection with an acquisition in January 2000. CORPORATE INFORMATION We were incorporated in California in April 1987. Our principal executive offices are located at 8001 Irvine Center Drive, Irvine, CA 92618 and our telephone number is (949) 754-8000. Our Web site is located at www.quest.com. Information contained on our Web site does not constitute part of this prospectus. Except as otherwise noted, all information in this prospectus assumes that the underwriters' over-allotment option is not exercised. 5 7 SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following table should be read with the consolidated financial statements and notes thereto appearing elsewhere in this prospectus. The as adjusted information reflects our receipt of the estimated net proceeds from the sale of 1,904,230 shares of our common stock offered by us hereby at a public offering price of $118.00 per share and the application of the estimated proceeds described in "Use of Proceeds."
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1995 1996 1997 1998 1999 ------ ------- ------- ------- ------- CONSOLIDATED STATEMENT OF INCOME DATA: Total revenues................................ $9,524 $12,862 $18,315 $34,790 $70,868 Gross profit.................................. 8,284 10,445 15,036 28,850 63,675 Income (loss) from operations................. 2,335 (372) 1,448 3,689 4,468 Net income.................................... 2,358 16 289 2,346 3,397 Net income applicable to common shareholders................................ 2,807 Basic and diluted net income per share:....... $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.07 Weighted average common shares outstanding: Basic....................................... 19,500 38,350 40,373 44,261 37,677 Diluted..................................... 19,500 38,350 40,617 44,459 41,800
DECEMBER 31, 1999 --------------------- ACTUAL AS ADJUSTED ------- ----------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $39,643 $253,231 Short-term marketable securities............................ 11,000 11,000 Working capital............................................. 38,670 252,258 Total assets................................................ 99,149 312,737 Retained earnings........................................... 1,864 1,864 Total shareholders' equity.................................. 62,669 276,257
6 8 RISK FACTORS An investment in our shares involves risks and uncertainties. You should carefully consider the factors described below before making an investment decision in our securities. The risks described below are the risks that we currently believe are material risks of business, the industry in which we compete and this offering. Our business, financial condition and results of operations could be adversely affected by any of the following risks. If we are adversely affected by such risks, then the trading price of our common stock could decline, and you could lose all or part of your investment. RISKS RELATED TO OUR BUSINESS OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, AND, AS A RESULT, WE MAY FAIL TO MEET EXPECTATIONS OF INVESTORS AND ANALYSTS, CAUSING OUR STOCK PRICE TO FLUCTUATE OR DECLINE Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors. These factors include the following: - the size and timing of customer orders. See "-- The size and timing of our customer orders may vary significantly from quarter to quarter which could cause fluctuations in our revenues." - increased expenses, whether related to sales and marketing, product development or administration; - our ability to attain market acceptance of new products and services and enhancements to our existing products; - delays in introducing new products; - new product introductions by competitors; - lack of order backlog; - changes in our pricing policies or the pricing policies of our competitors; - costs related to acquisitions of technologies or businesses; - the timing of releases of new versions of third-party software products that our products support, including, without limitation, product releases by Oracle; and - the amount and timing of expenditures related to expansion of our operations. THE SIZE AND TIMING OF OUR CUSTOMER ORDERS MAY VARY SIGNIFICANTLY FROM QUARTER TO QUARTER WHICH COULD CAUSE FLUCTUATIONS IN OUR REVENUES In any given quarter, sales of some of our products have involved large financial commitments from a relatively small number of customers, and cancellation or deferral of these large contracts would reduce our revenues. In addition, the sales cycles for Vista Plus and SharePlex have been up to six months and often require pre-purchase evaluation periods and customer education. These relatively long sales cycles may cause significant periodic variation in our license revenues. Also, we have often booked a large amount of our sales in the last month or weeks of each quarter and delays in the closing of sales near the end of a quarter could cause quarterly revenue to fall short of anticipated levels. Finally, while a portion of our revenues each quarter is recognized from previously deferred revenue, our quarterly performance will depend primarily upon entering into new contracts to generate revenues for that quarter. MANY OF OUR PRODUCTS ARE DEPENDENT ON ORACLE'S TECHNOLOGIES AND IF ORACLE'S TECHNOLOGIES LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS, THE DEMAND FOR OUR PRODUCTS COULD SUFFER We believe that our success has depended in part, and will continue to depend in part for the foreseeable future, upon our relationship with Oracle and our status as a complementary software provider for Oracle's database and application products. Many versions of our principal products, including 7 9 SharePlex, SQLab Xpert, and SQL Navigator, are designed specifically to be used with Oracle databases. Although a number of our products work with other environments, our competitive advantage consists in substantial part on the integration between our products and Oracle's products, and our extensive knowledge of Oracle's technology. Currently, a significant portion of our total revenues are derived from products that specifically support Oracle-based products. If Oracle for any reason decides to promote technologies and standards that are not compatible with our technology, or if Oracle loses market share for its database products, our business, operating results and financial condition would be materially adversely affected. MANY OF OUR PRODUCTS ARE VULNERABLE TO DIRECT COMPETITION FROM ORACLE We currently compete with Oracle in the market for database management solutions. We expect that Oracle's commitment to and presence in the database management product market will increase in the future and therefore substantially increase competitive pressures. We believe that Oracle will continue to incorporate database management technology into its server software offerings, possibly at no additional cost to its users. We believe that Oracle will also continue to enhance its database management technology. Furthermore, Oracle could attempt to increase its presence in this market by acquiring or forming strategic alliances with our competitors, and Oracle may be in better position to withstand and respond to the current factors impacting this industry. Oracle has a longer operating history, a larger installed base of customers and substantially greater financial, distribution, marketing and technical resources than we do. In addition, Oracle has well-established relationships with many of our present and potential customers. As a result, we may not be able to compete effectively with Oracle in the future which could materially adversely affect our business, operating results and financial condition. See "Business -- Competition." ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION We have in the past made and we expect to continue to make acquisitions of complementary companies, products or technologies. In this regard, we recently acquired MBR Technologies, Inc., Foglight Software, Inc., and QMaster Software Solutions, Inc. If we make any additional acquisitions, we will be required to assimilate the operations, products and personnel of the acquired businesses and train, retain and motivate key personnel from the acquired businesses. We may be unable to maintain uniform standards, controls, procedures and policies if we fail in these efforts. Similarly, acquisitions may subject us to liabilities and risks that are not known or identifiable at the time of the acquisition or may cause disruptions in our operations and divert management's attention from day-to-day operations, which could impair our relationships with our current employees, customers and strategic partners. We may have to incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our shareholders. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets. In consummating acquisitions, we are also subject to risks of entering geographic and business markets in which we have no or limited prior experience. If we are unable to fully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of acquisition. OUR ABILITY TO INCREASE OUR REVENUES DEPENDS ON OUR ABILITY TO EXPAND OUR INDIRECT SALES CHANNELS Our ability to increase revenues in the future substantially depends on our ability to expand our indirect sales channel. In certain domestic and international markets we may miss sales opportunities if we are unable to enter into successful relationships with locally based resellers. In the future, we intend to augment our current limited indirect sales distribution methods through additional third-party distribution arrangements and, therefore, we will likely become more dependent on these type of relationships. There can be no 8 10 assurance that we will successfully augment these arrangements or that the expansion of indirect sales distribution methods will increase revenues. OUR PAST AND FUTURE GROWTH MAY STRAIN OUR MANAGEMENT, ADMINISTRATIVE, OPERATIONAL AND FINANCIAL INFRASTRUCTURE We have recently experienced a period of rapid growth in our operations that has placed and will continue to place a strain on our management, administrative, operational and financial infrastructure. During this period, we have experienced an increase in the number of our employees, increasing demands on our operating and financial systems and personnel, and an expansion in the geographic coverage of our operations. The number of our full-time employees increased from 66 as of December 31, 1996 to 123 as of December 31, 1997, to 257 as of December 31, 1998, and to 654 as of December 31, 1999. Our ability to manage our operations and growth requires us to continue to improve our operational, financial and management controls, and reporting systems and procedures. In addition, we will be required to hire additional management, financial, and sales and marketing personnel to manage our expanding operations. If we are unable to manage this growth effectively, our business, operating results and financial condition may be materially adversely affected. WE MAY NOT GENERATE INCREASED BUSINESS FROM OUR CURRENT CUSTOMERS WHICH COULD SLOW OUR REVENUE GROWTH IN THE FUTURE Most of our customers initially make a purchase of our products for a single department or location. Many of these customers may choose not to expand their use of our products. If we fail to generate expanded business from our current customers, our business, operating results and financial condition could be materially adversely affected. In addition, as we deploy new modules and features for our existing products or introduce new products, our current customers may choose not to purchase this new functionality or these new products. Moreover, if customers elect not to renew their maintenance agreements, our service revenues would be materially adversely affected. BECAUSE THE MARKET FOR E-BUSINESS SOLUTIONS IS NEW AND EVOLVING, WE CANNOT ACCURATELY PREDICT THE FUTURE GROWTH RATE OF THIS MARKET OR ITS ULTIMATE SIZE We are increasingly focusing our selling efforts on providing application and information availability solutions for e-business applications and we expect such sales to constitute an increasing portion of our future revenue growth. We believe that most companies currently are not yet aware of our products and capabilities within this evolving market, and, as a result, such companies have not deployed our solutions. While we have devoted significant resources to promoting awareness of our products and the problems these products address for this evolving market, these efforts may not be sufficient to build market awareness of the need for our products. Failure of a significant market for e-business application and information availability products to develop, or failure of our products to achieve broad market acceptance, could have a material adverse effect on our business, operating results and financial condition. WE EXPECT TO INCUR SIGNIFICANT INCREASES IN OUR OPERATING EXPENSES IN THE FORESEEABLE FUTURE, WHICH MAY AFFECT OUR FUTURE PROFITABILITY We intend to substantially increase our operating expenses for the foreseeable future as we: - increase our sales and marketing activities, including expanding our direct sales and telesales forces; - increase our research and development activities; - expand our general and administrative activities; and - expand our customer support organizations. Accordingly, we will be required to significantly increase our revenues in order to maintain profitability. These expenses will be incurred before we generate any revenues by this increased spending. If we do not 9 11 significantly increase revenues from these efforts, our business and operating results would be negatively impacted. OUR INTERNATIONAL OPERATIONS AND OUR PLANNED EXPANSION OF OUR INTERNATIONAL OPERATIONS EXPOSES US TO CERTAIN RISKS Substantially all of our current international revenues are derived from the operations of our three wholly-owned subsidiaries in Australia, the United Kingdom and Germany. Revenues from licenses and services to customers outside of North America were $5.8 million in 1998, representing 16.7% of total revenues, and $15.3 million in the year ended December 31, 1999, representing 21.6% of total revenues. As a result, we face increasing risks from doing business on an international basis, including, among others: - difficulties in staffing and managing foreign operations; - longer payment cycles; - seasonal reductions in business activity in Europe; - increased financial accounting and reporting burdens and complexities; - potentially adverse tax consequences; - delays in localizing our products; - compliance with a wide variety of complex foreign laws and treaties; - reduced protection for intellectual property rights in some countries; and - licenses, tariffs and other trade barriers. In addition, because our international subsidiaries conduct business in the currency of the country in which they operate, we are subject to currency fluctuations and currency transaction losses or gains which are outside of our control. We plan to expand our international operations as part of our business strategy. The expansion of our existing international operations and entry into additional international markets will require significant management attention and financial resources and will place additional burdens on our management, administrative, operational and financial infrastructure. We cannot be certain that our investments in establishing facilities in other countries will produce desired levels of revenue or profitability. In addition, we have sold our products internationally for only a few years and we have limited experience in developing localized versions of our products and marketing and distributing them internationally. As our international operations expand, our exposure to exchange rate fluctuations will increase as we use an increasing number of foreign currencies. We have not yet entered into any hedging transactions to date to mitigate our expense to currency fluctuations. FAILURE TO DEVELOP STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS BY DENYING US SELLING OPPORTUNITIES AND OTHER BENEFITS Our current collaborative relationships may not prove to be beneficial to us, and they may not be sustained. We also may not be able to enter into successful new strategic relationships in the future, which could have a material adverse effect on our business, operating results and financial condition. From time to time, we have collaborated with other companies, including Hewlett-Packard and Oracle and certain regional offices of a number of the national accounting firms that provide system integration services, in areas such as product development, marketing, distribution and implementation. We could lose sales opportunities if we fail to work effectively with these parties. Moreover, we expect that maintaining and enhancing these and other relationships will become a more meaningful part of our business strategy in the future. However, many of our current partners are either actual or potential competitors with us. In addition, many of these third parties also work with competing software companies and we may not be 10 12 able to maintain these existing relationships, due to the fact that these relationships are informal or, if written, are terminable with little or no notice. OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED, AND THERE IS RISK OF INFRINGEMENT CLAIMS OR INDEPENDENT DEVELOPMENT OF COMPETING TECHNOLOGY THAT COULD HARM OUR COMPETITIVE POSITION Our success and ability to compete are dependent on our ability to develop and maintain the proprietary aspects of our technology. We rely on a combination of trademark, trade secret, copyright law and contractual restrictions to protect the proprietary aspects of our technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope of the proprietary rights of others. Any such resulting litigation could result in substantial costs and diversion of resources. Our means of protecting our proprietary rights may prove to be inadequate and competitors may independently develop similar or superior technology. Policing unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. We also believe that, because of the rapid rate of technological change in the software industry, trade secret and copyright protection are less significant than factors such as the knowledge, ability and experience of our employees, frequent product enhancements and the timeliness and quality of customer support services. Our success and ability to compete are also dependent on our ability to operate without infringing upon the proprietary rights of others. Third parties may claim infringement by us of their intellectual property rights. In the event of a successful claim of product infringement against us and our failure or inability to either license the infringed or similar technology or develop alternative technology on a timely basis, we may incur substantial licensing fees, be liable for infringement damage, or be unable to market our products. OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS ERRORS The software products we offer are inherently complex. Despite testing and quality control, we cannot be certain that errors will not be found in current versions, new versions or enhancements of our products after commencement of commercial shipments. Significant technical challenges also arise with our products because our customers purchase and deploy our products across a variety of computer platforms and integrate it with a number of third-party software applications and databases. If new or existing customers have difficulty deploying our products or require significant amounts of customer support, our operating margins could be harmed. Moreover, we could face possible claims and higher development costs if our software contains undetected errors or if we fail to meet our customers' expectations. As a result of the foregoing, we could experience: - loss of or delay in revenues and loss of market share; - loss of customers; - damage to our reputation; - failure to achieve market acceptance; - diversion of development resources; - increased service and warranty costs; - legal actions by customers against us which could, whether or not successful, increase costs and distract our management; and - increased insurance costs. 11 13 In addition, a product liability claim, whether or not successful, could harm our business by increasing our costs and distracting our management. WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR PRODUCTS AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE DEMAND FOR, OR PREVENT THE SHIPPING OF, OUR PRODUCTS Our SQL Navigator, TOAD, Vista Plus and Foglight products contain components developed and maintained by third-party software vendors. For example, we incorporate software licensed from Inso Corporation and Artifex Software into add-on options for our Vista Plus products. Similarly, our Foglight product incorporates software licensed from Inxight. We expect that we may have to incorporate software from third-party vendors in our future products. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete, defective or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the availability of these third-party software products or defects in these products could harm our sales unless and until we can secure an alternative source. Although we believe there are adequate alternate sources for the technology licensed to us by Inso, Artifex and Inxight, such alternate sources may not provide us with the same functionality as that currently provided to us. Further, we may experience a delay in obtaining an alternate source for the file viewing technology licensed to us by Inso if our license with Inso becomes unavailable for any reason. RISKS RELATED TO OUR INDUSTRY YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS AND COULD CAUSE DISRUPTION TO OUR BUSINESS Although we have not experienced any Year 2000 problems, it is possible that, even after January 1, 2000, Year 2000-related issues may cause problems or disruptions. While we believe that all of our systems are Year 2000 compliant, we cannot assure you that we will not discover a problem during 2000 that needs to be upgraded, modified or replaced. In addition, we depend on a number of third-party vendors to provide both information and non-information technology systems and services. While we believe that our material third-party systems and services are Year 2000 compliant, we cannot be sure that we will not experience any problems during 2000. We also cannot provide any assurance that governmental agencies, utility companies, Internet access companies and others outside of our control will not experience any future Year 2000 problems. THE DEMAND FOR OUR PRODUCTS WILL DEPEND ON OUR ABILITY TO ADAPT TO RAPID TECHNOLOGICAL CHANGE Our future success will depend on our ability to continue to enhance our current products and to develop and introduce new products on a timely basis that keep pace with technological developments and satisfy increasingly sophisticated customer requirements. Rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards characterize the market for our products. The introduction of products embodying new technologies and the emergence of new industry standards can render our existing products obsolete and unmarketable. As a result of the complexities inherent in today's computing environments and the performance demanded by customers for embedded databases and Web-based products, new products and product enhancements can require long development and testing periods. As a result, significant delays in the general availability of such new releases or significant problems in the installation or implementation of such new releases could have a material adverse effect on our business, operating results and financial condition. We may not be successful in: - developing and marketing, on a timely and cost-effective basis, new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements; - avoiding difficulties that could delay or prevent the successful development, introduction or marketing of these products; or - achieving market acceptance for our new products and product enhancements. 12 14 WE MAY NOT BE ABLE TO ATTRACT AND RETAIN PERSONNEL Our future success depends on the continued service of our executive officers and other key administrative, sales and marketing and support personnel, many of whom have recently joined our company. In addition, the success of our business is substantially dependent on the services of our Chief Executive Officer and our President and Chief Technical Officer. We intend to hire a significant number of additional sales, support, marketing, administrative and research and development personnel over at least the next 12 months. There has in the past been and there may in the future be a shortage of personnel that possess the technical background necessary to sell, support and develop our products effectively. Competition for skilled personnel is intense, and we may not be able to attract, assimilate or retain highly qualified personnel in the future. Our business may not be able to grow if we cannot attract qualified personnel. Hiring qualified sales, marketing, administrative, research and development and customer support personnel, is very competitive in our industry, particularly in Southern California, where Quest is headquartered. RISKS RELATED TO THIS OFFERING OUR OFFICERS AND DIRECTORS WILL BE ABLE TO EXERT SIGNIFICANT CONTROL ON QUEST AFTER THIS OFFERING Executive officers, directors and persons and entities affiliated with them will, in the aggregate, own approximately 71.5% of our outstanding common stock following this offering. These shareholders, if acting together, would be able to determine all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions. WE EXPECT THE PRICE OF OUR COMMON STOCK TO BE VOLATILE The market price of the common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: - quarterly variations in our operating results; - changes in financial estimates by securities analysts; - changes in market valuation of software and Internet companies; - announcements by us of significant contracts, acquisitions or capital commitments; - failure to complete significant license transactions; - additions or departures of key personnel; - any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts; - future sales of common stock; and - stock market price and volume fluctuations, which are particularly common among highly volatile securities of Internet and software companies. YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION The public offering price is substantially higher than the net tangible book value per share of the outstanding common stock after this offering. Accordingly, if you purchase common stock in this offering at the offering price of $118.00 per share, you will incur immediate and substantial dilution of $111.59 in the net tangible book value per share of the common stock from the price you pay for the common stock in this offering. A LARGE NUMBER OF SHARES OF OUR COMMON STOCK WILL BE ELIGIBLE FOR SALE SHORTLY AFTER THE OFFERING, WHICH COULD RESULT IN A DECLINE IN OUR STOCK PRICE Sales in the market of a substantial number of shares of common stock after the offering could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. Based on the shares of common stock outstanding as of December 31, 1999, on completion of this offering, we will have 40,809,574 shares of common stock 13 15 outstanding (based on the assumptions on page 5), and up to 41,439,574 shares if the underwriters' option to purchase additional shares is exercised from the Company in full (although all or a significant portion of the over-allotment option may be sold by existing shareholders). The 4,200,000 shares sold in this offering, which would be 4,830,000 shares if the underwriters' option to purchase additional shares is exercised in full and sold by the Company, 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. 31,728,589 of the remaining shares of common stock outstanding on completion of this offering will be "restricted securities" as that term is defined in Rule 144. Some of our stock and substantially all of our option holders are subject to agreements that limit their ability to sell common stock. These holders cannot sell or otherwise dispose of any shares of common stock for a period of at least 90 days after the date of this prospectus without the prior written approval of FleetBoston Robertson Stephens Inc. When these agreements expire, these shares and the shares underlying the options will become eligible for sale, in some cases only pursuant to the volume, manner of sale and notice requirements of Rule 144. See "Shares Eligible for Future Sale" and "Underwriting." 14 16 INFORMATION REGARDING FORWARD-LOOKING STATEMENTS Some of the matters discussed under the captions "Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus include forward-looking statements. We have based these forward-looking statements on currently available information and our current beliefs, expectations and projections about future events, including, among other things, - successfully implementing our business strategy; - maintaining and expanding market acceptance of the products we offer; and - our ability to successfully compete in our marketplace. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "potential," "continue," "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions. All forward-looking statements contained herein are subject to numerous risks and uncertainties. Our actual results and events may vary significantly from those discussed in the forward-looking statements. In light of these assumptions, risks and uncertainties, the forward-looking events discussed in this prospectus might not occur. 15 17 USE OF PROCEEDS The net proceeds to us from the sale of the 4,200,000 shares of common stock offered hereby will be approximately $213,587,679 million to the Company and $258,710,321 to the selling shareholders based upon an estimated offering price per share of $118.00 and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of the shares of our common stock being offered by the selling shareholders in this prospectus. We intend to use the net proceeds of this offering to the Company for general corporate purposes, including working capital, expanding our sales and marketing efforts, product development, expanding our customer support organization, possible acquisitions and capital expenditures. The other principal purposes of this offering are to increase our financial flexibility, facilitate our future access to public equity markets and increase our visibility in the marketplace. As of the date of this prospectus, we cannot specify with certainty the particular uses for the net proceeds to be received upon the closing of this offering. Pending other uses, the net proceeds of this offering will be invested in short-term, interest-bearing investment-grade instruments. From time to time, in the ordinary course of business, we evaluate possible acquisitions of, or investments in, businesses, products and technologies that are complementary to our business. A portion of the net proceeds may be used to fund acquisitions or investments. In January and February of 2000, we signed letters of intent to acquire two companies for a total purchase price in cash and stock of $25 million, plus in one instance, certain earnouts. Neither of the proposed acquisitions is a material transaction either individually or in the aggregate to us. There can be no assurance that we will close either or both acquisitions. DIVIDEND POLICY Prior to our conversion to a C corporation for tax purposes in January 1997, we paid distributions to our S corporation shareholders in amounts generally consistent with their tax liabilities arising from their allocable share of S corporation earnings. Since becoming a C corporation, we have not declared or paid any cash dividends on our common stock and do not expect to do so in the foreseeable future. We currently intend to retain all available funds for use in the operation and expansion of our business. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual and legal restrictions and other factors the board deems relevant. PRICE RANGE OF OUR COMMON STOCK Our common stock has been listed on the Nasdaq National Market since August 13, 1999 under the symbol "QSFT." The following table sets forth the high and low closing sale prices on the Nasdaq National Market for our common stock for the calendar periods indicated.
PRICE RANGE OF COMMON STOCK --------------------- HIGH LOW --------- -------- YEAR ENDED DECEMBER 31, 1999: Third Quarter (from August 13)...................... $ 52.3750 $32.5625 Fourth Quarter...................................... 116.5000 45.8750 YEAR ENDING DECEMBER 31, 2000: First Quarter (through March 2)..................... $118.5000 $ 74.50
On March 2, 2000, the last reported sale price of our common stock on the Nasdaq National Market was $118.00 per share. As of December 31, 1999, there were 59 holders of record of our common stock. 16 18 CAPITALIZATION The Actual column in the following table sets forth our actual capitalization as of December 31, 1999. The As Adjusted column in the following table gives effect to the sale of 1,904,230 shares of common stock in this offering by the Company at an estimated public offering price of $118.00 per share and the application of the estimated net proceeds therefrom. See "Use of Proceeds" and the notes to our consolidated financial statements. The As Adjusted information set forth below should be read in conjunction with our consolidated financial statements and the notes thereto.
DECEMBER 31, 1999 ----------------------- ACTUAL AS ADJUSTED -------- ----------- (DOLLARS IN THOUSANDS) Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized; no shares issued or outstanding, actual and as adjusted... $ -- $ -- Common stock, no par value; 75,000,000 shares authorized; 38,905,344 and 39,905,344 shares issued and outstanding, actual and as adjusted.................................... 94,010 307,598 Retained earnings........................................... 1,864 1,864 Accumulated other comprehensive income (loss)............... (26) (26) Notes receivable from sale of common stock.................. (3,115) (3,115) Capital distribution in excess of basis in common stock..... (30,064) (30,064) -------- --------- Total shareholders' equity................................ 62,669 276,257 -------- --------- Total capitalization...................................... $ 62,669 $ 276,257 ======== =========
The information in the table above excludes: - - 5,061,200 shares of common stock issuable upon exercise of stock options outstanding as of February 16, 2000, at a weighted average exercise price of $7.14 per share; - - 190,974 shares of common stock issued upon the exercise of options between January 1, 2000 and February 16, 2000; - - 2,210,320 shares of common stock reserved for future issuance under our stock incentive plans; - - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan, of which 119,097 shares were issued in February 2000. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and Note 8 of the notes to our consolidated financial statements; and - - 1,187,603 shares of common stock issued in connection with an acquisition in January 2000. 17 19 SELECTED CONSOLIDATED FINANCIAL DATA You should read the following selected consolidated financial data in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus. The following selected consolidated statement of income data for the years ended December 31, 1997, 1998 and 1999, and the consolidated balance sheet data at December 31, 1998 and 1999, have been derived from audited consolidated financial statements included elsewhere in this prospectus. The consolidated data presented below for the years ended December 31, 1995 and 1996, and at December 31, 1995, 1996 and 1997, are derived from audited consolidated financial statements that are not included in this prospectus. The data presented below do not include pro forma adjustments to reflect the income tax provision as if we were a C corporation in fiscal years 1995 and 1996.
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1995 1996 1997 1998 1999 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF INCOME DATA: Revenues: Licenses.................................. $ 7,219 $ 9,316 $12,158 $24,901 $54,269 Services.................................. 2,305 3,546 6,157 9,889 16,599 ------- ------- ------- ------- ------- Total revenues.................... 9,524 12,862 18,315 34,790 70,868 ------- ------- ------- ------- ------- Cost of revenues: Licenses.................................. 260 950 1,307 3,433 2,998 Services.................................. 980 1,467 1,972 2,507 4,195 ------- ------- ------- ------- ------- Total cost of revenues............ 1,240 2,417 3,279 5,940 7,193 ------- ------- ------- ------- ------- Gross profit................................ 8,284 10,445 15,036 28,850 63,675 Operating expenses: Sales and marketing....................... 2,179 4,328 5,845 11,836 32,078 Research and development.................. 1,134 2,995 4,293 8,047 15,980 General and administrative................ 2,636 3,494 3,450 5,278 9,906 Other compensation costs and goodwill amortization........................... -- -- -- -- 1,243 ------- ------- ------- ------- ------- Total operating expenses.......... 5,949 10,817 13,588 25,161 59,207 ------- ------- ------- ------- ------- Income (loss) from operations............... 2,335 (372) 1,448 3,689 4,468 Other income (expense), net................. 51 389 (137) 336 1,202 ------- ------- ------- ------- ------- Income before income tax provision.......... 2,386 17 1,311 4,025 5,670 Income tax provision........................ 28 1 1,022 1,679 2,273 ------- ------- ------- ------- ------- Net income.................................. $ 2,358 $ 16 $ 289 $ 2,346 3,397 ======= ======= ======= ======= ------- Preferred stock dividends................... 590 ------- Net income applicable to common shareholders.............................. $ 2,807 ======= Basic and diluted net income per share...... $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.07 Weighted average shares outstanding: Basic..................................... 19,500 38,350 40,373 44,261 37,677 Diluted................................... 19,500 38,350 40,617 44,459 41,800
DECEMBER 31, ---------------------------------------------- 1995 1996 1997 1998 1999 ------ ------- ------- ------- ------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents.................... $2,709 $ -- $ 2,096 $ 8,981 $39,643 Short-term marketable securities............. -- -- -- -- 11,000 Working capital.............................. 2,594 553 374 2,771 38,670 Total assets................................. 6,171 6,408 9,713 19,645 99,149 Total shareholders' equity................... 2,996 2,429 2,836 5,074 62,669
18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations also should be read in conjunction with the consolidated financial statements and notes to those statements included elsewhere in this prospectus. OVERVIEW We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications, and enable the delivery of information across the entire enterprise. We were incorporated in 1987. At our inception, we focused on developing and marketing software which supported developers and users of Hewlett Packard's HP 3000 proprietary operating system known as MPE. In 1995, Vincent C. Smith joined us as a director and in 1997, he became our chief executive officer. In 1995, we began to transition our focus from proprietary MPE technology to open system technology. Additionally, commencing in 1995, we began extending our Vista Plus product to open system architectures, and in 1998, we extended Vista Plus to support the Internet. In 1996, we acquired R*Tech which developed SQLab, our first product series for Oracle databases. In 1997, we made a number of additional acquisitions which augmented the product line for managing Oracle databases including our SQL Navigator, I/Watch and Schema Manager products. Beginning in late 1997, we also began a major expansion of our research and development, sales and marketing, and customer support organizations by adding personnel in all departments, and through an acquisition, the establishment of operations in Australia and the United Kingdom. Commencing in the second half of 1998, we also introduced several additional products including SharePlex and SQLab Xpert. In 1998, we also established a direct sales operation in Germany. In 1999, we introduced Instance Monitor and Data Manager. In December 1999, we acquired MBR Technologies, Inc. and its Stat! product for consideration consisting of 93,471 shares of our common stock valued at $9.3 million and a cash payment of $1.3 million, and the assumption of net liabilities of $340,000. Of the total purchase price, which included direct acquisition costs, $11.5 million was allocated to goodwill, which will be amortized over a five-year period, and $784,000 was allocated to assumed liabilities. In January 2000, we acquired Foglight Software, Inc. and its Foglight product for consideration consisting of 1,187,603 shares of our common stock valued at $104.2 million, cash payment of $0.4 million, the assumption of unvested Foglight stock options valued at $2.2 million and the assumption of net liabilities of $4.1 million. The total purchase price, which included direct acquisition costs, is estimated to be allocated primarily to goodwill and other intangible assets, which will be amortized primarily over a five-year period. In February 2000, we acquired QMaster Software Solutions, Inc. and the QMaster Output product for $15 million in cash. The total purchase price, which will include direct costs of the acquisition estimated to be $75,000, is estimated to be allocated primarily to goodwill, which will be amortized over a five-year period. We derive our revenues primarily from the sale of software licenses and related annual maintenance fees. Our total revenues have increased over each of the past five fiscal years, from $9.5 million in 1995 to $70.9 million in 1999. Pricing of our software licenses is based on the number of servers, workstations and/or users of our products. Annual maintenance contracts may be purchased separately by customers at their discretion. We recognize software license revenues when a non-cancellable license agreement has been signed with a customer, the software is shipped, no significant post-delivery vendor obligations remain and collection is deemed probable. Maintenance revenues are recognized ratably over the contract term, which is typically one year. Revenues for consulting services are recognized as such services are performed. See Note 1 of the notes to our consolidated financial statements. 19 21 We market our software and services primarily through our direct sales organization in the United States, Australia, the United Kingdom and Germany. International revenues from licenses and services sold to customers outside of North America were $1.4 million in 1997, $5.8 million in 1998, and $15.3 million in 1999. We intend to expand our international sales activities as part of our business strategy. All of our current international revenues are derived from the operations of our three wholly owned subsidiaries in Australia, the United Kingdom and Germany. Our international subsidiaries conduct business in the currency of the country in which they operate, exposing us to currency fluctuations and currency transaction losses or gains which are outside of our control. Historically, fluctuations in foreign currency exchange rates have not had a material effect on our business. We have not, to date, conducted any hedging transactions to reduce our risk to currency fluctuations. In the development of new products and enhancements of existing products, the technological feasibility of the software is not established until substantially all product development is complete. Historically, our software development costs eligible for capitalization have been insignificant, and all costs related to internal research and development have been expensed as incurred. At the time of our incorporation, we elected to be treated as an S corporation under Subchapter S of the Internal Revenue Code. As an S corporation, our shareholders were liable for federal income tax liabilities resulting from our operations. Effective January 1, 1997, we terminated our status as an S corporation and for all periods thereafter, we have been liable for federal income taxes. Prior to the termination of our S corporation status, we declared distributions as dividends to shareholders payable in cash in an amount generally equal to the tax consequence created by our earnings up to the date of such termination. 20 22 RESULTS OF OPERATIONS The following table sets forth certain consolidated statement of income data as a percentage of total revenues for the periods indicated:
YEAR ENDED DECEMBER 31, ----------------------- 1997 1998 1999 ----- ----- ----- Revenues: Licenses.................................................. 66.4% 71.6% 76.6% Services.................................................. 33.6 28.4 23.4 ----- ----- ----- Total revenues.................................... 100.0 100.0 100.0 ----- ----- ----- Cost of revenues: Licenses.................................................. 7.1 9.9 4.2 Services.................................................. 10.8 7.2 5.9 ----- ----- ----- Total cost of revenues............................ 17.9 17.1 10.1 ----- ----- ----- Gross profit................................................ 82.1 82.9 89.9 Operating expenses: Sales and marketing....................................... 31.9 34.0 45.3 Research and development.................................. 23.5 23.1 22.6 General and administrative................................ 18.8 15.2 14.0 Other compensation costs and goodwill amortization........ -- -- 1.8 ----- ----- ----- Total operating expenses.......................... 74.2 72.3 83.7 ----- ----- ----- Income from operations...................................... 7.9 10.6 6.2 Other (expense) income, net................................. (0.7) 0.9 1.7 ----- ----- ----- Income before income tax provision.......................... 7.2 11.5 7.9 Income tax provision........................................ 5.6 4.8 3.2 ----- ----- ----- Net income.................................................. 1.6% 6.7% 4.7% ===== ===== =====
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 REVENUES Revenues were $18.3 million, $34.8 million and $70.9 million for 1997, 1998 and 1999, respectively, representing increases of $16.5 million, or 90.2%, from 1997 to 1998, and $36.1 million, or 103.7% from 1998 to 1999. International revenues accounted for 7.4%, 16.7% and 21.6% of total revenues for 1997, 1998 and 1999, respectively. No customer accounted for more than 10.0% of total revenues in 1997, 1998 or 1999. Licenses -- Licenses were $12.2 million, $24.9 million and $54.3 million in 1997, 1998 and 1999, respectively, representing increases of $12.7 million, or 104.1%, from 1997 to 1998, and $29.4 million or 118.1% from 1998 to 1999. Licenses represented 66.4%, 71.6% and 76.6% of total revenues in 1997, 1998 and 1999, respectively. International licenses accounted for 8.2%, 18.6% and 23.4% of total licenses in 1997, 1998 and 1999, respectively. The increase in licenses from 1997 to 1998 was due to the expansion of our domestic sales organization of 67 people, a $3.6 million increase in international license revenue, greater market acceptance of our products for Oracle database market and the success of our Vista Plus product for the UNIX environment. The increase in licenses from 1998 to 1999 was due to both an increase in our worldwide sales force of 176 people, as well as the availability of new products for all of 1999 including Schema Manager, I/Watch and TOAD. Services -- Services were $6.2 million, $9.9 million and $16.6 million in 1997, 1998 and 1999, respectively, representing increases of $3.7 million, or 60.6%, from 1997 to 1998, and $6.7 million or 67.7% from 1998 to 1999. Services represented 33.6%, 28.4% and 23.4% of total revenues in 1997, 1998 and 1999, 21 23 respectively. The increases in services reflects the increase in the number of software licenses sold with maintenance agreements. International services accounted for 5.7%, 11.9% and 15.9% of total services in 1997, 1998 and 1999, respectively. COST OF REVENUES Cost of Licenses -- Cost of licenses was $1.3 million, $3.4 million and $3.0 million in 1997, 1998 and 1999, respectively, representing an increase of $2.1 million, or 161.5%, from 1997 to 1998, and a decrease of $.4 million or 11.8% from 1998 to 1999. Cost of licenses as a percentage of license revenue was 10.8%, 13.8% and 5.5% for 1997, 1998 and 1999, respectively. The increase in cost of licenses as a percentage of license revenue from 1997 to 1998 was attributable primarily to a $1.8 million increase in royalties and a $551,000 increase in amortization of purchased technology and software licenses. The decrease in cost of licenses from 1998 to 1999, was due to decreases for both royalties and amortization as a result of reaching several royalty maximums and completion of amortization of certain purchased technology. Cost of Services -- Cost of services was $2.0 million, $2.5 million and $4.2 million in 1997, 1998 and 1999, respectively, representing increases of $500,000, or 25.0%, from 1997 to 1998 and $1.7 million or 68.0% from 1998 and 1999. The increases over these periods were primarily due to an increase in the number of customer support personnel to service our growing customer and product base. Cost of services as a percentage of service revenues was 32.0%, 25.4% and 25.3% for 1997, 1998 and 1999, respectively. The decreases in cost of services as a percentage of services over these periods were primarily due to economies of scale realized as a result of our increasing service revenues. OPERATING EXPENSES Sales and Marketing -- Sales and marketing expenses were $5.8 million, $11.8 million and $32.1 million in 1997, 1998 and 1999, respectively, representing increases of $6.0 million, or 103.4%, from 1997 to 1998, and $20.3 million or 172.0% from 1998 to 1999. The increases reflect our increasing investment in our sales and marketing organization, which from 1997 to 1998 included a $3.6 million increase in salaries and related expenses, a $1.1 million increase in additional commissions, and a $353,000 increase in marketing communications expenses such as trade shows and advertising. The increases from 1998 to 1999 reflect an increase in salaries and related expenses of $8.9 million, a $4.3 million increase in commissions and a $627,000 increase in marketing communications expenses. Travel and entertainment expenses, and related costs of hiring sales and marketing management also increased for both periods. Research and Development -- Research and development expenses were $4.3 million, $8.0 million and $16.0 million in 1997, 1998 and 1999, respectively, representing increases of $3.7 million, or 86.0%, from 1997 to 1998, and $8.0 million or 100.0% from 1998 to 1999. The increases for these periods were primarily related to a 63 person increase from 1997 to 1998, and a 138 person increase from 1998 to 1999 in the number of software developers and quality assurance personnel and, to a lesser extent, an increase in the cost of hiring outside contractors to support product development activities. General and Administrative -- General and administrative expenses were $3.5 million, $5.3 million and $9.9 million in 1997, 1998 and 1999, respectively, representing an increase of $1.8 million, or 51.4%, from 1997 to 1998, and an increase of $4.6 million or 86.8% from 1998 to 1999. The most significant expense increases during both periods were for salaries and related expenses and rent. Other compensation costs and goodwill amortization -- Compensation costs and goodwill amortization was $1.2 million in 1999 and includes $715,000 related to the severance package provided to Doran Machin, one of our founders and a director, which will be paid out over a three-year period, $432,000 of compensation costs related to the grant of stock options at less than fair market value and $97,000 of goodwill amortization related to acquisitions. Other Income (Expense), net -- Other income (expense), net was $(137,000) in 1997, $336,000 in 1998, and $1.2 million in 1999, representing an increase of $473,000 from 1997 to 1998, and $864,000 22 24 from 1998 to 1999. The increases reflect increased interest income from higher cash and short-term investments which accelerated in 1999 after the receipt of the IPO proceeds. Provision for Income Taxes -- Provision for income taxes was $1.0 million, $1.7 million and $2.3 million in 1997, 1998 and 1999, respectively, representing increases of $700,000, or 70.0%, from 1997 to 1998, and an increase of $600,000 or 35.3% from 1998 to 1999. The effective income tax rate was 78.0%, 41.7% and 40.1% in 1997, 1998 and 1999, respectively. The high effective tax rate in 1997 is attributable to our election, effective January 1, 1997, to terminate our status as an S corporation under federal tax regulations which resulted in the establishment of deferred taxes. See Note 6 of the notes to our consolidated financial statements. INFLATION Inflation has not had a significant effect on our results of operations or financial position for the years ended December 31, 1997, 1998 and 1999. 23 25 QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited consolidated statement of operations data for the ten quarters in the period ended December 31, 1999, as well as such data expressed as a percentage of total revenues for the periods indicated. This data has been derived from our unaudited consolidated financial statements that have been prepared on the same basis as the audited consolidated financial statements included in this prospectus and, in the opinion of our management, include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information when read in conjunction with the consolidated financial statements and the notes thereto included in this prospectus. These quarterly results have been in the past and may in the future be subject to significant fluctuations. As a result, we believe that results of operations for interim periods should not be relied upon as any indication of the results to be expected in any future period.
THREE MONTHS ENDED --------------------------------------------------------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, 1997 1997 1998 1998 1998 1998 1999 1999 --------- -------- -------- -------- --------- -------- -------- -------- (IN THOUSANDS) Revenues: Licenses............................ $3,066 $3,887 $4,840 $4,740 $6,190 $ 9,131 $ 9,540 $11,825 Services............................ 1,405 1,665 2,203 2,252 2,544 2,890 3,299 3,625 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues.................... 4,471 5,552 7,043 6,992 8,734 12,021 12,839 15,450 ------ ------ ------ ------ ------ ------- ------- ------- Cost of revenues: Licenses............................ 179 730 557 947 1,081 848 684 720 Services............................ 500 578 521 523 609 854 904 834 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of revenues............ 679 1,308 1,078 1,470 1,690 1,702 1,588 1,554 ------ ------ ------ ------ ------ ------- ------- ------- Gross profit.......................... 3,792 4,244 5,965 5,522 7,044 10,319 11,251 13,896 Operating expenses: Sales and marketing................. 1,461 1,874 1,923 2,448 3,169 4,296 5,036 7,122 Research and development............ 1,087 1,120 1,766 1,863 1,928 2,490 2,758 3,276 General and administrative.......... 900 978 841 1,229 980 2,228 1,938 2,051 Other compensation costs and goodwill amortization............. -- -- -- -- -- -- -- 775 ------ ------ ------ ------ ------ ------- ------- ------- Total operating expenses.......... 3,448 3,972 4,530 5,540 6,077 9,014 9,732 13,224 ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) from operations......... 344 272 1,435 (18) 967 1,305 1,519 672 Other (expense) income, net........... (9) 18 48 71 106 111 113 (31) ------ ------ ------ ------ ------ ------- ------- ------- Income before income tax provision.... 335 290 1,483 53 1,073 1,416 1,632 641 Income tax provision.................. 262 227 615 22 446 596 689 270 ------ ------ ------ ------ ------ ------- ------- ------- Net income............................ $ 73 $ 63 $ 868 $ 31 $ 627 $ 820 $ 943 $ 371 ====== ====== ====== ====== ====== ======= ======= ======= Preferred stock dividends............. -- -- -- -- -- -- -- 340 ------ ------ ------ ------ ------ ------- ------- ------- Net income applicable to common shareholders........................ $ 73 $ 63 $ 868 $ 31 $ 627 $ 820 $ 943 $ 31 ====== ====== ====== ====== ====== ======= ======= ======= AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses............................ 68.6% 70.0% 68.7% 67.8% 70.9% 76.0% 74.3% 76.5% Services............................ 31.4 30.0 31.3 32.2 29.1 24.0 25.7 23.5 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues.................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ------ ------ ------ ------ ------ ------- ------- ------- Cost of revenues: Licenses............................ 4.0 13.2 7.9 13.5 12.3 7.1 5.3 4.7 Services............................ 11.2 10.4 7.4 7.5 7.0 7.1 7.1 5.4 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of revenues............ 15.2 23.6 15.3 21.0 19.3 14.2 12.4 10.1 ------ ------ ------ ------ ------ ------- ------- ------- Gross profit.......................... 84.8 76.4 84.7 79.0 80.7 85.8 87.6 89.9 Operating expenses: Sales and marketing................. 32.7 33.8 27.3 35.1 36.3 35.8 39.2 46.1 Research and development............ 24.3 20.2 25.1 26.6 22.1 20.7 21.5 21.2 General and administrative.......... 20.1 17.5 11.9 17.6 11.2 18.5 15.1 13.3 Other compensation costs and goodwill amortization............. -- -- -- -- -- -- -- 5.0 ------ ------ ------ ------ ------ ------- ------- ------- Total operating expenses.......... 77.1 71.5 64.3 79.3 69.6 75.0 75.8 85.6 ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) from operations......... 7.7 4.9 20.4 (0.3) 11.1 10.8 11.8 4.3 Other (expense) income, net........... (0.2) 0.3 0.6 1.0 1.2 0.9 0.9 (0.2) ------ ------ ------ ------ ------ ------- ------- ------- Income before for income tax provision........................... 7.5 5.2 21.0 0.7 12.3 11.7 12.7 4.1 Income tax provision.................. 5.9 4.1 8.7 0.3 5.1 5.0 5.4 1.7 ------ ------ ------ ------ ------ ------- ------- ------- Net income............................ 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% 7.3% 2.4% ====== ====== ====== ====== ====== ======= ======= ======= Preferred stock dividends............. -- -- -- -- -- -- -- 2.2 ------ ------ ------ ------ ------ ------- ------- ------- Net income applicable to common shareholders........................ 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% 7.3% 0.2% ====== ====== ====== ====== ====== ======= ======= ======= THREE MONTHS ENDED -------------------- SEPT. 30, DEC. 31, 1999 1999 --------- -------- (IN THOUSANDS) Revenues: Licenses............................ $13,995 $18,909 Services............................ 4,313 5,362 ------- ------- Total revenues.................... 18,308 24,271 ------- ------- Cost of revenues: Licenses............................ 734 860 Services............................ 1,154 1,303 ------- ------- Total cost of revenues............ 1,888 2,163 ------- ------- Gross profit.......................... 16,420 22,108 Operating expenses: Sales and marketing................. 8,321 11,599 Research and development............ 4,502 5,444 General and administrative.......... 2,787 3,130 Other compensation costs and goodwill amortization............. 186 282 ------- ------- Total operating expenses.......... 15,796 20,455 ------- ------- Income (loss) from operations......... 624 1,653 Other (expense) income, net........... 278 842 ------- ------- Income before income tax provision.... 902 2,495 Income tax provision.................. 380 934 ------- ------- Net income............................ $ 522 $ 1,561 ======= ======= Preferred stock dividends............. 250 -- ------- ------- Net income applicable to common shareholders........................ $ 272 $ 1,561 ======= ======= AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses............................ 76.4% 77.9% Services............................ 23.6 22.1 ------- ------- Total revenues.................... 100.0 100.0 ------- ------- Cost of revenues: Licenses............................ 4.0 3.5 Services............................ 6.3 5.4 ------- ------- Total cost of revenues............ 10.3 8.9 ------- ------- Gross profit.......................... 89.7 91.1 Operating expenses: Sales and marketing................. 45.5 47.8 Research and development............ 24.6 22.4 General and administrative.......... 15.2 12.9 Other compensation costs and goodwill amortization............. 1.0 1.2 ------- ------- Total operating expenses.......... 86.3 84.3 ------- ------- Income (loss) from operations......... 3.4 6.8 Other (expense) income, net........... 1.5 3.5 ------- ------- Income before for income tax provision........................... 4.9 10.3 Income tax provision.................. 2.0 3.9 ------- ------- Net income............................ 2.9% 6.4% ======= ======= Preferred stock dividends............. 1.4 -- ------- ------- Net income applicable to common shareholders........................ 1.5% 6.4% ======= =======
24 26 Our total revenues have increased in each period presented, with the exception of the three months ended June 30, 1998. These increases have been generally due to increased acceptance of our products and the expansion of our sales force and increased service revenues as the installed customer base has grown. Total cost of revenues have also generally increased in absolute dollars over these periods presented due to increased amortization of purchased technology and software licenses, royalty costs, and an increase in the number of customer support personnel. Total operating expenses have increased in absolute dollars in each period presented as we have grown our infrastructure to support our expanding operations. While we have not experienced a significant amount of seasonality in the past, we expect that we will begin to experience seasonal customer buying patterns in the foreseeable future. Specifically, we would expect to experience relatively stronger demand for our products during the quarters ending December 31 and June 30, and relatively weaker demand in the quarters ending March 31 and September 30. In addition, to the extent international operations constitute a greater percentage of our revenues in future periods, we anticipate that demand for our products in Europe will decline during the summer vacation season. LIQUIDITY AND CAPITAL RESOURCES We have funded our business, to date, primarily from cash generated by our operations and net proceeds of $64.9 million from our initial public offering in August 1999. Our sources of liquidity as of December 31, 1999, consisted principally of cash and cash equivalents of $39.6 million and marketable securities of $15.5 million. Net cash provided by operating activities was $3.6 million, $8.2 million and $11.4 million in 1997, 1998 and 1999, respectively. The increases in 1997, 1998 and 1999, were primarily due to increases in net income, depreciation and amortization, deferred revenue resulting from additional service contracts and accrued expenses, offset by increases in accounts receivable resulting from increased sales. Net cash used in investing activities was $1.3 million, $1.3 million, and $24.1 million in 1997, 1998, and 1999, respectively. The increase in cash used in investing activities in 1999 was primarily related to capital expenditures of $7.1 million associated with company growth and net purchases of marketable securities totalling $15.5 million. Financing activities used $270,000 and $8,000 in 1997 and 1998, respectively, and generated $43.6 million in 1999. In April 1999, we raised $25.0 million through the sale of preferred stock and an additional $10.0 million in term debt from a commercial bank in order to purchase shares of common stock from a shareholder and founder for $35.0 million. See "Certain Transactions" and Note 4 of the notes to our consolidated financial statements. In August of 1999, we raised net proceeds of $64.9 million from our initial public offering. A portion of the proceeds was utilized to retire debt of $10.9 million and redeem the outstanding Series B Preferred Stock for $10.0 million. We believe that the net proceeds from this offering, our existing cash and investment balances and cash from operations will be sufficient to finance our operations through at least the next 12 months. If additional financing is needed, there can be no assurance that such financing will be available to us on commercially reasonable terms or at all. 25 27 YEAR 2000 Prior to January 1, 2000, there was a great deal of concern regarding the ability of computers to adequately distinguish 21st century dates from 20th century dates due to the two-digit date fields used by many systems. Most reports to date, however, are that computer systems are functioning normally and the compliance and remediation work accomplished leading up to the Year 2000 was effective to prevent any problems. Computer experts have warned that there may still be residual consequences of the change in centuries and any such difficulties could result in a decrease in sales of our products, an increase in allocation of resources to address Year 2000 problems of our customers without additional revenue commensurate with such dedication of resources, or an increase in litigation costs relating to losses suffered by our customers due to such Year 2000 problems. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard , or SFAS, No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes methods for derivative financial instruments and hedging activities related to those instruments, as well as other hedging activities. Because we do not currently hold any derivative instruments and do not currently engage in hedging activities, we expect that the adoption of SFAS No. 133 will not have a material impact on our financial position or results of operations. We will be required to implement SFAS No. 133 for the year ending December 31, 2001. In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions. SOP 98-9 amends SOP 97-2 and SOP 98-4, extending the deferral of the application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. We do not expect the adoption of SOP 98-9 to have a material effect on our results of operations or financial condition. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVES AND FINANCIAL INSTRUMENTS FOREIGN CURRENCY HEDGING INSTRUMENTS We transact business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to revenues and operating expenses in Australia, the United Kingdom and Germany denominated in the respective local currency. To date, we have not used hedging contracts to hedge our foreign-currency fluctuation risks. We will assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis. We also do not use derivative financial instruments for speculative trading purposes. INTEREST RATE RISK The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company has not used derivative financial instruments in its investment portfolio. The Company places its investments with high-quality issuers and, by policy, limits the amount of credit exposure to any one issuer. The Company's investments in marketable securities consist primarily of high-grade corporate and government securities with maturities of less than two years. Investments purchased with an original maturity of three months or less are considered to be cash equivalents. The Company classifies all of its investments as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. At December 31, 1999, the net loss on available-for-sale securities of $26 is comprised of five positions, all with unrealized losses. 26 28 EUROPEAN MONETARY UNION Within Europe, the European Economic and Monetary Union introduced a new currency, the euro, on January 1, 1999. The new currency is in response to the European Union's policy of economic convergence to harmonize trade policy, eliminate business costs associated with currency exchange, and to promote the free flow of capital, goods and services. On January 1, 1999, the participating countries adopted the euro as their local currency, initially available for currency trading on currency exchanges and non-cash transactions such as banking. The existing local currencies, or legacy currencies, will remain legal tender through January 1, 2002. Beginning on January 1, 2002, euro-denominated bills and coins will be issued for cash transactions. For a period of up to six months from this date, both legacy currencies and the euro will be legal tender. On or before July 1, 2002, the participating countries will withdraw all legacy currencies and exclusively use the euro. Our transactions are recorded in both U.S. dollars and foreign currencies. Future transactions may be recorded in the euro. We have not incurred and do not expect to incur any significant costs from the continued implementation of the euro. However, the currency risk of the euro could harm our business. 27 29 BUSINESS This prospectus contains certain forward looking statements within the meaning of the federal securities laws. Actual results and the timing of certain events could differ materially from those projected in the forward looking statements due to a number of factors, including those set forth under "Risk Factors" and elsewhere in this prospectus. OVERVIEW We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems by utilizing a number of integrated products that enhance the performance of applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database products that maintain a real-time copy of a database for offloading critical systems and assuring high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, manages and distributes report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. INDUSTRY BACKGROUND Organizations are constantly seeking ways to use information and technology to gain competitive advantages. To compete more effectively, organizations must deliver relevant information and provide increasingly sophisticated and time-sensitive services to a rapidly expanding audience, including employees, customers, suppliers and partners both inside and outside of the traditional enterprise. Today, a growing number of organizations are using the Internet to conduct business electronically. In embracing this e-business model, enterprises are attempting to maximize the value of their information technology infrastructure as they extend their business over the Internet to directly reach a large number of geographically dispersed end-users. The fundamental changes brought on by the increasing reliance on information technology, including today's rapidly expanding e-business initiatives, are introducing new complexities and transforming business practices: - Decisions need to be made in real-time by personnel at all levels both inside and outside the enterprise; - Users demand relevant information immediately and without interruption, and have increasingly high expectations regarding response time; - New software applications must be developed, and existing applications need to be extended over the Internet; and - Organizations must deploy new applications and technologies at an increasingly rapid pace. Underlying each of these requirements is the importance of effective management and distribution of information. While raising the strategic importance of real-time, dynamic information, today's e-business initiatives have heightened the challenges of developing and managing the systems to deliver it. For example, if an electronic commerce application fails, the relationship between the organization and the customer is jeopardized, giving new meaning to the term "mission critical." As a result, organizations must assure that their systems provide: - Application availability -- uninterrupted and high performance access to applications under widely varying conditions; and - Information availability -- broad distribution of critical business information from underlying applications to decision makers throughout the entire enterprise. 28 30 Application Availability The challenge of today's competitive environment is to provide users with the ability to immediately execute transactions and access information, without regard to the underlying complexities inherent in the disparate systems that run business applications. Since the emergence of e-business has allowed consumers to directly communicate with an organization's systems, it is more important than ever before to maximize application performance and minimize downtime. Furthermore, as e-business, enterprise resource planning and other applications are deployed to a wider audience, rapid and unpredictable spikes in the number of users can dramatically increase the likelihood of performance degradation and system failure. Not only must organizations have adequate back-up systems in place, but they also need solutions that will enable them to proactively monitor, identify and resolve issues that can adversely affect application performance. Finally, to ensure true application availability, organizations need solutions that will enable them to quickly and accurately develop and deploy new applications and modifications to existing applications. Information Availability In addition to assuring the availability of applications, the imperatives of e-business require organizations to make the strategic information within these applications readily available to the users who need it. The Internet has created a platform for distributing critical, dynamic business information, such as inventory levels, requisitions, billing statements, manufacturing data and sales reports to a broad range of employees, partners and suppliers, many of whom may be located in geographically remote locations and connected through multiple, non-integrated systems. Organizations must be able to leverage this platform to reach customers and provide 24x7x365 access to valuable information, including customer support and current account information. The challenge, however, is effectively extracting, publishing and disseminating large volumes of information to thousands of employees, customers, partners and suppliers over the Internet without massive amounts of application reengineering. Need for a Comprehensive Solution The effectiveness of an organization's information delivery system is dependent on its application availability environment. A user's ability to access information is linked to the performance and reliability of the underlying application. Historically, organizations have relied on a combination of manual processes and a heterogeneous assortment of software tools to manage the performance and reliability of their application infrastructure and to enable the distribution of information throughout the enterprise. However, the requirements of today's e-business initiatives have stretched the capabilities of these traditional solutions. This dynamic environment has created the need for a comprehensive solution that will address the breadth of these application and information availability requirements: - Deliver data from multiple, heterogeneous sources, scale to thousands of users and deliver information across all environments, quickly and cost-effectively; - Provide high performance and reliability for 24x7x365 access, and minimize the strain on existing systems and personnel; - Be easy to use and deploy without requiring in-depth technical expertise; - Adapt to accommodate rapidly changing business needs; - Provide an architecture to realize immediate value for Web-based applications; and - Address these requirements across the entire Web, application and database environments. 29 31 THE QUEST SOLUTION Quest offers application and information availability software solutions that enhance the performance and reliability of e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Key elements of our solution include: Assure Application Availability We offer a family of products that enhance the reliability and performance of software applications. Our application availability products enable the development of efficient and reliable Internet-enabled applications; accurately deploy database and application changes; provide replication solutions for fail-over capability, data distribution and distributing load across multiple systems; and proactively monitor, diagnose and resolve database and system performance issues before they are noticed by the end-user. Our products are designed to maintain the continuous availability of applications to the enterprise, not only in terms of uptime, but also in terms of providing adequate performance under a wide range of operating conditions. As a result, information technology personnel are able to efficiently and proactively enhance the performance and reliability of critical business applications. Extend the Reach of Information We enable enterprises to deliver information internally and externally via the Internet to reach employees, customers and partners throughout large and geographically dispersed organizations. Our Web-based information availability solutions enable access to a greater number of users, minimize the delay in publishing information and reduce manual printing and delivery costs associated with paper-based report distribution. For example, these solutions can integrate with corporate portals to allow for delivery of personalized information to a user's desktop through a Web browser. We optimize the storage and distribution of information by publishing information once from disparate applications to a centralized repository. This repository serves as a common platform to capture and distribute information without taxing the application systems or the network. Our solution is designed to empower decision-makers by providing relevant, dynamic information, more quickly and more cost-effectively than previously possible. Leverage the Web Our products allow organizations to leverage the functionality and flexibility of the Internet to address the high-performance demands of e-business environments. Specifically, our products are designed to adapt to the varying bandwidth and response times encountered on the Internet with efficient and fault-tolerant architectures; employ Java-based interfaces to deliver transparent Web access to business information; and ensure the security and integrity of Web-based access to applications. Maximize Investment in Existing Technology We enable organizations to enhance the capabilities and extend the benefits of their existing information technology infrastructure. Our products enable existing enterprise and custom applications to reach throughout and beyond the enterprise without requiring re-engineering. Additionally, we enable our customers to improve the reliability and performance of existing information technology infrastructure to cost-effectively and predictability support the increasing number of users and large volumes of transactions required by today's e-business applications. Easy to Deploy and Use Our products are easy to deploy and use, thereby minimizing implementation, training and support costs. We designed our products to be installed quickly by the customer, typically without the need for on-site assistance. Our products contain specific integration modules for SAP R/3, PeopleSoft and Oracle Financials, enabling rapid deployment in these environments, minimizing the need for customization and reducing ongoing maintenance requirements. 30 32 Architected to Scale Our products are well-suited for large, enterprise-wide deployments. We designed our products to effectively scale when implemented in large and rapidly expanding environments without compromising system performance. Our products support heterogeneous networks, manage large quantities of information and support thousands of users while at the same time minimizing the consumption of network and computing resources. Our Java user interfaces significantly reduce the need for client-side software management, effectively leveraging today's wide deployment of Internet browser technology. STRATEGY Our objective is to become the leading provider of application and information availability solutions to enable organizations to deliver relevant information and provide sophisticated services to employees, customers, suppliers and partners both inside and outside of the traditional enterprise. Key elements of our strategy include: Extend Product Leadership We offer a family of products that work together to provide application and information availability solutions capable of meeting today's performance requirements. We believe our family of application availability products provides the most thorough and efficient approach to optimizing the performance and availability of e-business, enterprise and custom applications. We also believe that we offer the leading Web-based information availability software solutions in terms of functionality and innovation. We intend to advance this product leadership by investing significantly in research and development and by acquiring and integrating complementary products and technologies. We intend to strengthen and expand our offerings of integration software for leading enterprise resource planning (ERP) applications. Our flexible and open architecture allows for the integration of new modules that enhance our current solutions and add new e-business functionality, such as electronic bill presentment. We plan to augment our existing application availability solutions with capabilities to monitor and maintain the underlying infrastructure of e-business applications. For example, we plan to introduce a product that manages and optimizes the performance of Web application servers. Focus on e-Business Applications Market We believe that both recent and expected growth in e-business applications have created strong demand for our application and information availability products. We intend to capitalize on this opportunity by actively marketing our products to companies with strong e-business initiatives. In addition to developing new e-business applications, organizations are attempting to improve the e-business functionality of their existing enterprise applications by extending them over the Internet. As a result, we believe a significant market opportunity exists to help organizations leverage these investments by incorporating new e-business functionality into these systems. We believe that our products will be used as a key component of the infrastructure for emerging e-business applications. Leverage our Significant Installed Base of Customers We have an installed base of thousands of customers that we believe provides us with a significant opportunity for additional sales of current and future products, as well as ongoing maintenance revenues. A majority of our customers have purchased only one or a few of our products or use our products in specific business-units or locations. We believe that we can sell more deeply into our installed customer base by expanding these departmental deployments into enterprise-wide implementations as well as by cross-selling additional products and services. Expand our Sales Force and Distribution Channels We market and sell our products worldwide primarily though a direct sales and telesales force. We believe that our direct sales approach allows us to achieve better control of the sales process and respond 31 33 more quickly to customer needs while maintaining an efficient sales model. We are continuing to expand our direct sales efforts both domestically and internationally. Sales outside of North America represented approximately 17% of total revenue in 1998 and 22% in 1999, and we believe that there is significant untapped demand for our software products internationally. We intend to continue to expand our direct sales staff and increase the number of sales offices internationally, and, to a lesser extent, develop alliances with international distributors. Extend Strategic Integrator Relationships We intend to increase the value of our solutions to customers by offering additional and improved consulting and implementation services for our enterprise-level software solutions. Specifically, we plan to extend our existing strategic relationships and develop new partnerships with leading global systems integrators who specialize in implementing software solutions that support e-business and enterprise application software. We believe that these relationships will both facilitate the successful enterprise deployment of our products and generate additional product sales opportunities. 32 34 PRODUCTS Our products are designed to work individually and together to provide immediate and continuous availability of applications and information, both of which are critical as enterprises rapidly extend their information technology infrastructure. Our products and their functionality are summarized below:
- ------------------------------------------------------------------------------------------------------------ INFORMATION AVAILABILITY - ------------------------------------------------------------------------------------------------------------ VISTA PLUS Captures, manages and distributes report-based information through an enterprise report and document repository. - ------------------------------------------------------------------------------------------------------------ VISTA PLUS E-PURPOSING MODULE Extends information delivery across the Internet by providing global delivery of time-sensitive documents, electronic bill and statement presentment without requiring application changes. - ------------------------------------------------------------------------------------------------------------ VISTA PLUS INTERFACE MODULES FOR SAP Provides rapid installation and continuous synchronization R/3, PEOPLESOFT, AND ORACLE of users, groups, authorization profiles and report APPLICATIONS information from ERP systems to Vista Plus. - ------------------------------------------------------------------------------------------------------------ QMASTER* A web-based, enterprise-wide solution for delivering, managing, and monitoring nearly all printed, faxed or emailed output throughout an organization. - ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------ APPLICATION AVAILABILITY - ------------------------------------------------------------------------------------------------------------ DATABASE REPLICATION - ------------------------------------------------------------------------------------------------------------ SHAREPLEX(R) REPLICATION Replicates high volumes of data from Oracle databases to improve performance and manage future growth. - ------------------------------------------------------------------------------------------------------------ ENTERPRISE MONITORING - ------------------------------------------------------------------------------------------------------------ FOGLIGHT* Monitors and resolves problems across the hardware and software components that comprise modern applications, including the network, application servers, database servers and web servers, from a Java-based centralized console. - ------------------------------------------------------------------------------------------------------------ I/WATCH Offers a centralized console for monitoring, alerting, diagnosing and resolving problems in Oracle-based applications. - ------------------------------------------------------------------------------------------------------------ DATABASE AND APPLICATION PERFORMANCE - ------------------------------------------------------------------------------------------------------------ INSTANCE MONITOR A real-time monitoring and diagnostic tool featuring visual representation of database process flows. - ------------------------------------------------------------------------------------------------------------ SQLAB XPERT Identifies and resolves database resource consumption problems caused by poorly performing application code by recommending optimal tuning scenarios. - ------------------------------------------------------------------------------------------------------------ SPACE MANAGER Reorganizes database objects and performs capacity planning to improve performance and manage future growth. - ------------------------------------------------------------------------------------------------------------ APPLICATION CHANGE MANAGEMENT - ------------------------------------------------------------------------------------------------------------ SCHEMA MANAGER Manages database change and migration from development through production by providing comprehensive version control, auditing and rollback capabilities. - ------------------------------------------------------------------------------------------------------------ DATA MANAGER Builds test databases, deploys reference data to production during software rollouts, extracts data for data warehouses or reporting databases, and purges or archives production data that is not needed on-line. - ------------------------------------------------------------------------------------------------------------ SQL IMPACT Manages interdependencies between database objects and application source code, providing detailed impact analysis, documentation and auditing. - ------------------------------------------------------------------------------------------------------------ SQL NAVIGATOR AND TOAD Server-side database development and management solutions with optional add-on modules available for debugging, SQL tuning with expert advice and integrated code libraries for rapid development. - ------------------------------------------------------------------------------------------------------------ STAT! Tracks and manages all customizations made by an organization to their PeopleSoft implementations. Changes can be unapplied or reapplied to new versions of PeopleSoft automatically, an otherwise highly complex and error prone process. - ------------------------------------------------------------------------------------------------------------
- ------------------------- * Products acquired after December 31, 1999 33 35 INFORMATION AVAILABILITY Vista Plus. Our Vista Plus products deliver the benefits of enabling Web-based access to existing information and applications without a complex development or deployment effort. Vista Plus is an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application. Vista Plus maintains a repository of this output for instant distribution over a heterogeneous, widely distributed network, including the Internet, with our sophisticated Java or Windows clients. By storing output from applications in its repository, Vista Plus also eliminates the processing needed to rerun reports, and its report mining capabilities provide users access to information without burdening the primary systems. Vista Plus enables real-time access to business-critical information at any time, even if the source application is not accessible. Vista Plus provides the ability to quickly navigate from summary to detailed information, data extraction, hyperlinks to navigate between related information and numerous print and electronic distribution functions with no application changes, delivering immediate benefits throughout the enterprise. The robust security model built into Vista ensures that only authorized users gain access to data. Vista Plus further extends information availability by transforming production reports into a series of personalized emails, PDF files or HTML pages for Internet distribution of statements such as invoices, purchase orders and financial statements. As a result, the data that is delivered to end users contains relevant information in a familiar and highly usable format. QMaster provides a scalable, open architecture solution which automates Output Delivery to printers, faxes, email, electronic documents and the scheduling and execution of Batch Processes in a heterogeneous environment of NT and UNIX platforms. QMaster supports a wide variety of incompatible operating systems and devices. Nearly any form of output can automatically be routed across a variety of high and low speed printers, securely, in order to optimize use of resources and ensure information is successfully delivered even if a device becomes unavailable. The web-based user interface allows the control of delivery of documents from anywhere over the Internet. APPLICATION AVAILABILITY We provide a broad range of products that together provide a comprehensive application availability solution. Our products provide a wide range of services that work together to maintain the high level of performance and continuous access required by today's demanding e-business environment. Integration between these components significantly enhances the value of each solution by increasing user productivity and delivering otherwise unavailable functionality. Database Replication SharePlex. SharePlex replicates high volumes of data from an Oracle database to one or more other databases. Replication is accomplished in real-time with very little overhead to critical application servers. Secondary systems can then be used for offloading non-critical processing, thus preserving desired user response times and Web server performance, as well as providing a back-up system for reporting and fail-over. SharePlex also supports wide-area networks without the need for expensive high bandwidth data links. Enterprise Monitoring Foglight. Foglight is a new generation Enterprise Monitoring solution that monitors all components of a modern application system, including web servers, application servers, and database servers. Applications being deployed today offer increasing complexity involving multiple systems and software packages that are interdependent. Understanding the relationship between these software and hardware components and how they interact and affect each other is often difficult. Foglight's correlation technology allows system administrators to determine where performance bottlenecks are occurring for rapid resolution. Foglight provides an extensible and scalable platform which can be used for end-to-end monitoring in the most demanding and dynamic environments. 34 36 I/Watch. I/Watch offers a central console for Oracle-based applications and alerts the operations staff of problems as they develop. I/Watch is easy to deploy and consumes relatively few system resources. I/Watch detects system and application failures, and allows operations staff to watch for developing problems over a large network of systems. I/Watch can alert and automatically respond with appropriate measures to resource problems. I/Watch provides an intuitive, graphical interface that clearly shows where problems are occurring and supports the ability to quickly navigate from summary to detailed information for diagnosing and resolving issues. I/Watch allows for the mining of previously monitored time periods to help pinpoint the root cause of problems. Database and Application Performance Instance Monitor. Instance Monitor is a real-time monitoring and diagnostic tool featuring visual representations of process flows within the database. Instance Monitor's unique user-interface design displays a comprehensive diagram of a database's internal workings and the flow of information within the database. Instance Monitor tracks database performance in real-time, identifies potential bottlenecks and provides detailed expert advice to help resolve problems as they occur. SQLab Xpert. SQLab Xpert automatically locates and highlights poorly written database application code. It provides expert advice to help both novice and seasoned developers and administrators quickly find solutions to difficult performance problems. Space Manager. Space Manager addresses the complex issues of physical data management to help keep application performance at peak levels. As database structures are modified to accommodate application changes and growth, performance begins to degrade due to poor physical organization of information within the database. Space Manager is designed to perform this necessary maintenance as well as assist in planning for future growth in storage requirements. Application Change Management SQL Impact. SQL Impact scans application code and stores it in its repository. If a change is needed to any object in a database, SQL Impact determines which programs and specific lines of code will be affected, reducing the likelihood of overlooking required application changes. Schema Manager. Schema Manager automatically determines the differences between a development and production database and can synchronize the databases automatically. Schema Manager packages all of the changes needed for a new application deployment, checks to make sure the changes will not fail in the production environment, and implements the changes. Its auditing capability documents all database changes, allowing the immediate rollback of a change if required. Data Manager. Data Manager deploys and transforms data when new applications are rolled out, for example, storing or changing reference data such as sales tax tables and control information. Data Manager also creates test databases for developers, eliminating the need to use a full copy of a production database which can be impractical due to its large size. Stat! Stat! provides users of the PeopleSoft ERP and Human Resources software with a method to track and preserve all changes and customizations made to a PeopleSoft implementation. Since modification of standard packaged software like PeopleSoft is often necessary, managing these changes becomes critical to preserving the customized software environment. With integrated workflow, Stat! is a centralized repository for documenting, tracking, migrating, supporting and delivering PeopleSoft application changes. Customizations are safeguarded and preserved without risk of losing them. By using Stat!, organizations can greatly reduce the effort required to implement upgraded versions of PeopleSoft's applications, a process that is otherwise highly resource intensive, time consuming and expensive. Database Programming SQL Navigator and TOAD enable development of server side code for databases, a key component of Internet-enabled application development. SQL Navigator and TOAD allow developers to rapidly and 35 37 accurately develop and enhance the performance of applications. Providing similar functionality, these two products incorporate different user interfaces that increase their appeal to a broader spectrum of developers and database administrators. They integrate with our other application availability products, enabling developers to check and correct the performance of their code before it is put into production. CUSTOMERS AND CASE STUDIES Our software products are licensed to customers worldwide to provide a wide range of application and availability solutions. Our products have been sold to thousands of corporations, governmental agencies and other organizations worldwide. In 1997, 1998 and 1999, no customer accounted for more than 10% of our total revenues. A representative sampling of customers who have purchased at least $100,000 of software licenses and support services includes: TECHNOLOGY FINANCIAL SERVICES MANUFACTURING Akamai ADP 3M Applied Materials AIG Marketing American Cyanamid Dell Computer American National Bank Avery Dennisson Earthlink Ceridian Tax Service Boeing Hewlett-Packard Chase Manhattan Mortgage Eaton Corp. Intuit Citibank General Electric Plastics Mail.com Credit Suisse/First Boston Honeywell Merisel Cyber Cash Imation Micro Warehouse DLJ Direct Johnson Controls Micron Electronics Fidelity Investments Koch Industries Motorola First National Bank Chicago Lockheed Martin Oracle FleetBoston Robertson Stephens Monsanto Priceline.com GE Capital Sara Lee Hosiery Sony Mercury Insurance Group Smuckers Sun Microsystems Nations Bank Toyota Motors Yahoo Wellington Management Weyerhaeuser HEALTHCARE/PHARMACEUTICAL Wells Fargo OTHER TELECOMMUNICATIONS 3M Health Information Systems American Home Shield Acuson Air Touch Communications Andersen Consulting Blue Cross-Blue Shield (FL) AT&T Aramark Bristol Meyers British Telecom Bausch & Lomb Worldwide Cardinal Health Lucent Technologies Carlson Companies GE Medical Systems MCI System House Circuit City Harvard Pilgrim Health Care Nextel ConAgra Hoechst Marion Roussel Southwestern Bell Mobile Dun & Bradstreet Info. Systems Hoffman LaRoche Communications Earth Tech Kaiser Permanente TCI Communications Hertz Merck Williams Information Services JC Penney US Surgical Musicland ENERGY Pepsi-Cola PriceWaterhouseCoopers Detroit Edison Purdue University FirstEnergy Corp. State of Georgia Pennsylvania Power & Light Time Inc. PG&E Texas Management United Space Alliance Shell Services International University of Michigan Sun Chemical Yamaha Valero Energy Wisconsin Power & Light
The following case studies illustrate how a selected group of representative customers are using a variety of Quest products to ensure high application and information availability across their increasingly 36 38 heterogeneous and distributed networks. We compiled this information in consultation with the companies listed below. Applied Materials Applied Materials is a leading semiconductor equipment manufacturer. To improve efficiency in its global operations, Applied Materials needed a Web-based enterprise-wide report management solution that could seamlessly integrate with their existing applications, automate their processes and provide instant access to corporate reports to thousands of employees worldwide. Such a solution would eliminate the need to prepare, compile and distribute thousands of corporate reports manually. Applied Materials selected and implemented Vista Plus as an enterprise-wide report warehouse and distribution solution for automated electronic delivery and archiving of application reports. We believe that Applied Materials was able to realize cost savings and productivity benefits immediately. Administrative overhead was reduced through lower paper and printing costs and reduced human resource expenses. Moreover, Applied Materials deployed Vista Plus without having to reconfigure its existing applications. After experiencing the benefits of Vista Plus, Applied Materials purchased I/Watch, for enterprise monitoring and SQLab Xpert for application turning, to improve the availability and performance of their Oracle database environment. EarthLink EarthLink is a leading Internet service provider, with a full range of innovative access and hosting solutions used by approximately 1.15 million individuals and businesses every day. Using Oracle databases, EarthLink needed a better way to diagnose and address day-to-day application availability and management issues. Due to the size and the dynamic nature of its business, downtime would be catastrophic. EarthLink selected our products to satisfy its requirements in this area. To manage its applications, EarthLink uses I/Watch and Instance Monitor for database monitoring, diagnostics and resolution. Based on our discussions with EarthLink, we believe that they particularly liked the user interfaces and integration of the products they purchased. We also believe that these products, along with SQLab Xpert, enable their database administrators to perform "targeted tuning" with intelligent tuning recommendations that improve the performance of the databases. Space Manager provides EarthLink with a comprehensive solution for database reorganization and capacity planning for application availability through preventive maintenance, problem detection and resolution across all databases. NCR NCR provides integrated software, consulting services and hardware solutions for businesses. NCR runs Oracle in a multi-platform environment with a combination of applications, including Oracle Financials, PeopleSoft and other internally developed solutions. NCR employs over 300 servers worldwide and executes mission-critical data transfers. This complexity required a controlled application development and deployment environment. Our change management products allow NCR to facilitate the identification, migration and deployment of critical database changes required to ensure that all databases have the same structure across the entire enterprise. NCR uses SQL Impact to identify the interdependencies between application source code and the database objects. NCR uses Schema Manager to synchronize and migrate database structural changes between development and production databases. In addition, they use SQLab Tuner to tune complex queries and SQL Navigator for server-side development and debugging. As a result of implementing our products, we believe that NCR was able to realize a reduction in processing time by improving code integrity and reducing development time. Priceline.com On April 6, 1998, priceline.com opened its virtual doors to pioneer a new level of service that allows online consumers to "name your price and save" on an array of goods and services from airline tickets to home mortgages. Because priceline.com's customers can only purchase product via the Internet, the Web site is the business and therefore depends on continuous availability. To ensure this availability, priceline.com turned to our SharePlex replication solution. SharePlex protects priceline.com from downtime by providing live, up-to-the-minute copies of their production databases to not only balance the workload of thousands of consumers, but also provide a backup in the event of a failure. SharePlex 37 39 was the only solution available that met the requirements of priceline.com's demanding environment. Creating the environment required for around the clock access poses one of the greatest challenges Internet companies face today. SharePlex not only solved this problem but also provided geographical redundancy to both priceline.com sites, located in Connecticut and New Jersey. SALES, MARKETING AND DISTRIBUTION We market and sell our products and services worldwide through a combination of direct sales and telesales forces and, to a lesser extent, resellers and distributors. Our domestic sales organization is headquartered in Irvine, California. We have additional sales offices located in the metropolitan areas of Atlanta, Boston, Chicago, Dallas, Detroit, New York, Raleigh, San Francisco and Washington D.C. We also have international sales offices in the metropolitan areas of Frankfurt, London and Melbourne. We are continuing to expand our sales organization and establish additional sales offices domestically and internationally. We also sell certain of our products through our Web site, which allows our customers to conveniently download our products for evaluation and direct purchase. Our sales and marketing approach is designed to help customers understand both the business and technical benefits of our products. Accordingly, we complement the efforts of our sales organization with a pre-sale customer support organization that is responsible for addressing technical questions related to our products. The sales team for each customer is responsible for maintaining appropriate contacts with key information technology personnel who have planning and purchasing responsibility within the customer's organization. Since a number of our products affect systems and employees throughout the enterprise, our sales effort typically involve technology presentations and pilot implementations, and many times involve numerous decision makers. As a result, a key feature of our sales efforts is to establish relationships at all appropriate levels in our customers' organizations. While the sales cycle varies substantially from customer to customer, the typical sales cycle for our Vista Plus and SharePlex products has ranged from three to six months. Focusing on our target markets, our marketing efforts are designed to create awareness for our products and generate sales leads. To achieve these goals, we engage in a variety of marketing activities, including seminars, trade shows, direct mailings and print and Web-based advertising. In addition, we have recently expanded our marketing staff and intend to commence an ongoing public relations program that will include establishing and maintaining relationships with key trade press, business press and industry analysts. We also intend to initiate a customer advisory council which will provide a communication channel for regular feedback from key customers to facilitate the design of products to meet the expanding requirements of our target market. CUSTOMER SERVICE AND SUPPORT A high level of customer service and support is critical to the successful marketing and sale of our products and the development of long-term customer relationships. Our customer support group provides technical support to our customers under support agreements entered into at the time of the initial sale. Our base level of e-mail-, Internet-, fax-, and telephone-based support includes assistance with installation, configuration and initial set-up of our products; ongoing support during normal business hours; and software maintenance and upgrade releases. For an additional fee, we provide support on a 24x7x365 basis as well as training and other services. Customer support is provided domestically through our offices in Irvine and internationally through our offices in Europe and Australia. We plan to hire additional support personnel and, as needed, establish additional support sites domestically and internationally to meet our customers' needs. Furthermore, we plan to extend our existing strategic partnerships and develop new partnerships with leading systems integrators to provide implementation guidance, assistance with configuration and initial set-up of applications. Our services contracts are generally of 12 months' duration and are renewable at the customer's option. Service contracts are generally priced at approximately 20% of the amount of licenses and the customer is invoiced annually in advance. 38 40 RESEARCH AND DEVELOPMENT We believe that strong research and product development capabilities are essential to enhancing our core technologies and developing additional products that offer maximum value and ease of use. We have invested significant time and resources in creating a structured process for undertaking product development projects. This process is designed to provide the proper framework for defining and addressing the steps, tasks and activities required to bring product concepts and development projects to market successfully. A significant portion of our development effort is conducted in Melbourne, Australia. We have actively recruited key software engineers and developers with expertise in the areas of Oracle technologies, SQL Server, Java, Microsoft development technologies, ERP systems, IBM database technologies and document management. Our engineers include several of the industry's leading database management authorities. Complementing these individuals, our senior management has extensive background in the database, network infrastructure and enterprise and system software industries. Our research and development efforts focus on designing and developing reliable, easy to install and use products that solve application and information availability problems for our customers. Since our inception in 1987, we have made substantial investments in research and development through both internal development and technology acquisitions. Our products utilize a number of advanced technologies including the log analysis component of SharePlex that allows quick and accurate determination of the database structural and data changes with minimal overhead. Another example is our Vista Plus product line which contains highly sophisticated postscript and PCL parsing technology that allows these products to understand complex output data streams, enabling search, transformation and extraction from graphics-intensive output. COMPETITION The market for application and information availability solutions is emerging rapidly, and, as a result, is intensely competitive and characterized by rapidly changing technology and evolving standards. We expect competition to continue to increase both from existing competitors and new market entrants. We believe that our ability to effectively compete depends on many factors, including: - the ease of use, performance, features, price and reliability of our products as compared to those of our competitors; - the timing and market acceptance of new products and enhancements to existing products developed by us and our competitors; - the quality of our customer support; and - the effectiveness of our sales and marketing efforts. Companies currently offering competitive products vary in the scope and breadth of the products and services offered and include: - providers of enterprise report management products such as Computer Associates, Mobius, Hewlett Packard and IBM; - providers of hardware and software replication tools such as EMC and Veritas; and - providers of database and database management products such as BMC, Compuware, Oracle, and Computer Associates. Many of our competitors and potential competitors have greater name recognition, a larger installed customer base company-wide and significantly greater financial, technical, marketing, and other resources than we do. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. In addition, because there are relatively low barriers to entry in the software market, we may encounter additional competition as other established and emerging companies enter our field and introduce new products and technologies. 39 41 In addition, providers of database solutions such as Oracle, Microsoft and IBM currently produce database management tools and may in the future enhance their products to include functionality that is currently provided by our products. The inclusion of the functionality of our software as standard features of the underlying database solution or application supported by our products could render our products obsolete and unmarketable, particularly if the quality of such functionality were comparable to that of our products. Even if the functionality provided as standard features by these system providers is more limited than that of our software, there can be no assurance that a significant number of customers would not elect to accept more limited functionality in lieu of purchasing additional software. Moreover, there is substantial risk that the mere announcements of competing products by large competitors such as Oracle could result in the delay or cancellation of customer orders for our products in anticipation of the introduction of such new products. In addition to the competition that we may face because of the internal development efforts of our competitors, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing their ability to address the needs of our current or prospective customers. Accordingly, it is possible that new competitors or alliances among current and new competitors may emerge and rapidly gain significant market share. Such competition could also materially adversely affect our ability to sell our products or to obtain maintenance and support renewals for existing licenses on terms favorable to us. There can be no assurance that we will be able to compete successfully against current and future competitors. Increased competition could result in price reductions, fewer customer orders, reduced gross margins and loss of market share, any of which could materially affect our business, operating results or financial condition. PROPRIETARY RIGHTS Our success and ability to compete are dependent on our ability to develop and maintain the proprietary aspects of our technology. We rely on a combination of trademark, trade secret, copyright law and contractual restrictions to protect the proprietary aspects of our technology. We presently have no patents on our products. We currently hold several trademark registrations and have numerous trademark applications in the United States and certain foreign countries. Our trademark applications might not result in the issuance of any valid trademarks. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed or shrinkwrap license agreements, which impose restrictions on the licensee's ability to utilize the software. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, we sell our products internationally. The laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope of the proprietary rights of others. Any such resulting litigation could result in substantial costs and diversion of resources and would materially adversely affect our business, operating results and financial condition. We cannot assure you that our means of protecting our proprietary rights will be adequate or that competition will not independently develop similar or superior technology. We also believe that, because of the rapid rate of technological change in the software industry, trade secret and copyright protection are less significant than factors such as the knowledge, ability and experience of our employees, frequent product enhancements and the timeliness and quality of customer support services. Our success and ability to compete are also dependent on our ability to operate without infringing upon the proprietary rights of others. We are not aware that we are infringing any proprietary rights of third parties. There can be no assurance, however, that third parties will not claim we infringe their 40 42 intellectual property rights. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of product infringement against us and our failure or inability to either license the infringed or similar technology or develop alternative technology on a timely basis, our business, operating results and financial condition could be materially adversely affected. We incorporate technology from third parties into our SQL Navigator, TOAD, Vista Plus and Foglight products. We currently have a material license agreement with Inso for the use of file viewing technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Inso royalty fees based on sales of our Vista Plus product. This license agreement terminates on February 10, 2002. In addition, we currently have a material license agreement with Artifex for the use of technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Artifex royalty fees based on sales of Vista Plus products incorporating the licensed software. The license for the technology from Artifex remains in effect for so long as any proprietary rights in the licensed technology are enforceable under the laws of any jurisdiction, unless earlier terminated by us upon 30 days written notice or by Artifex upon a material breach by us. We also have a material license agreement with Inxight which is incorporated into the Foglight product. We currently pay Inxight a license fee per year plus royalty fees equal to a percentage of the license fee. The license agreement terminates September 30, 2002. As we continue to introduce new products, we may be required to license additional technology from others. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms, if at all. SharePlex is a registered trademark owned by us. This prospectus also makes reference to the other trademarks that we own, some of which we are seeking registration for, and to trademarks of other companies. EMPLOYEES As of December 31, 1999, we employed 654 full-time employees, including 299 in sales and marketing, 226 in research and development, 52 in customer service and support and 77 in general and administrative. We believe that our future success will depend in large part upon our continuing ability to attract and retain highly skilled managerial, sales, marketing, customer support and research and development personnel. Like other software companies, we face intense competition for such personnel, and we have at times experienced and continue to experience difficulty in recruiting qualified personnel. There can be no assurance that we will be successful in attracting, assimilating and retaining other qualified personnel in the future. We are not subject to any collective bargaining agreement and we believe that our relationships with our employees are good. FACILITIES Our principal administrative, sales, marketing, support and research and development facility is currently located in approximately 67,500 square feet of space in Irvine, California. This facility is under a six-year lease and we have an option to renew this lease for an additional five-year term. We also lease sales offices in the metropolitan areas of Atlanta, Boston, Calgary, Chicago, Dallas, Detroit, New York, Raleigh, San Francisco, and Washington, D.C. Our Chicago office is currently located in approximately 30,000 square feet in Warrenville, Illinois. This facility is under a 7-year lease. Our German subsidiary currently operates from two facilities in Frankfurt and Dusseldorf. Our Australian subsidiary operates from two leased facilities in Melbourne which total approximately 10,000 square feet. Our UK subsidiary leases a 5,300 square-foot office in the London metropolitan area. LEGAL PROCEEDINGS We are not currently a party to any material legal proceeding. 41 43 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information regarding our executive officers and directors as of February 1, 2000:
NAME AGE POSITION - ---- --- -------- Vincent C. Smith.............. 36 Chief Executive Officer and Chairman of the Board David M. Doyle(2)............. 39 President, Secretary and Director John J. Laskey................ 50 Chief Financial Officer and Vice President, Finance Eyal M. Aronoff............... 36 Vice President, Technology and Engineering Douglas F. Garn............... 41 Vice President, Worldwide Sales Doran G. Machin(1)(2)......... 45 Director Jerry Murdock, Jr.(1)(2)...... 41 Director
- ------------------------- (1) Member of Compensation Committee (2) Member of Audit Committee Set forth below is certain information regarding the business experience during the past five years of each of the above-named persons. Vincent C. Smith has served as our Chief Executive Officer since 1997 and a director since 1995. Mr. Smith became Chairman of the Board in 1998. In 1994, Mr. Smith was Director of Open Systems at BMC Software, where he managed its sales operations. From 1992 to 1994, Mr. Smith co-founded Patrol Software North America and served as its Vice President of Worldwide Sales and Marketing. Patrol Software merged with BMC in 1994. Mr. Smith worked at Oracle Corporation from 1987 to 1992 in a variety of sales management positions. Mr. Smith received his B.S. degree in Computer Science with a minor in Economics from University of Delaware. David M. Doyle is our President, Secretary, founder and a director. Mr. Doyle has been President and a director since the formation of Quest in 1987 and has been our Secretary since June 1999. Mr. Doyle was the primary designer and developer of our products during the initial four years after the founding of Quest. Prior to the founding of Quest, Mr. Doyle served as a consultant to a variety of industries, specializing in the areas of system design and application performance and co-founded American Data Industries. Mr. Doyle studied Information and Computer Sciences at University of California, Irvine. John J. Laskey is our Chief Financial Officer and Vice President, Finance. Mr. Laskey has held these positions since October 1998. From June 1995 to October 1998, Mr. Laskey served as the Chief Financial Officer and Vice President, Finance of Continuus Software Corporation, a provider of software change management solutions. From April to June 1995, Mr. Laskey was the Chief Financial Officer and Vice President, Finance of StarBase Corporation. From September 1986 to April 1995, Mr. Laskey worked at FileNet Corporation as Vice President, Finance and Principal Accounting Officer. Mr. Laskey received his B.S. degree in Electrical Engineering from University of Illinois and his M.B.A. from Loyola University of Chicago. Eyal M. Aronoff has been our Vice President of Technology and Engineering since March 1996, when we acquired R*Tech Systems, Inc., a database management company. Mr. Aronoff founded R*Tech Systems in 1992 and served as its President from 1992 to 1996. Prior to this, Mr. Aronoff worked for John Bryce Ltd., an Oracle distributor in Israel, attended school and served in the Israeli Defense Force. Mr. Aronoff received a B.A. degree in computer science and chemistry from Bar-Ilan University Ramat-Gan, Israel. Douglas F. Garn is the Vice President of Worldwide Sales. Mr. Garn has held this position since January 1998. From March 1996 to January 1998, Mr. Garn was Vice President of North American Sales for Peregrine Systems, Inc. From July 1995 until April 1996, Mr. Garn was Vice President of Sales with 42 44 Syntax, Inc., a networking software company. From November 1993 until July 1995, Mr. Garn was Regional Sales Manager with BMC. Mr. Garn holds a B.S. in Marketing from University of Southern California. Doran G. Machin has served as a director since 1987. Mr. Machin was also our Secretary and Executive Vice President from 1987 through April, 1999. Prior to 1987, Mr. Machin was employed as an independent computer consultant, worked for Hewlett-Packard and American Data Industries. Mr. Machin attended Cerritos College and California State University, Fullerton. Jerry Murdock, Jr. has served as a member of our board since April 1999. Since 1995, Mr. Murdock has been employed by InSight Capital Partners, an investment firm which he co-founded in that year. From 1987 to 1995, Mr. Murdock was President of Aspen Technology Group, a consulting firm which he founded in 1987. Mr. Murdock has a degree in Political Science from San Diego State University. Mr. Murdock is a member of the boards of directors of several private technology companies. KEY EMPLOYEES Kimberly A. Kinnison has been our Vice President of Technical Support since January 1999. As such, Ms. Kinnison oversees our management information systems department and our worldwide technical support staff. From January 1998 to January 1999, Ms. Kinnison was our Director of Technical Support and from June 1995 to December 1997, she was our Support Manager. Ms. Kinnison joined Quest in November 1991 as a technical support engineer. Prior to joining Quest, Ms. Kinnison held positions as a systems programmer at Hughes Aircraft and instructor/consultant at Hewlett Packard. Ms. Kinnison received her B.S. in Computer Information Systems from California State Polytechnic University, Pomona. Terence J. Mullin has been our Vice President of the Output Management Business Unit since April 1998. From November 1997 to April 1998, Mr. Mullin was the Vice President of Marketing and Business Development of Clarion Corporation of America's Advanced Technology Division. From April 1997 to November 1997, Mr. Mullin was the Vice President of Marketing and Business Development for NetSoft/NetManage. From April 1995 to April 1997, Mr. Mullin held the position of Strategic Planner of Internet Strategy and Marketing at FileNet Corporation. Mr. Mullin studied Computer Science at California State University, Fullerton and completed the Advanced Management Development in Business Administration program offered by the University of Southern California. Charles C. Ramsey has been our Vice President of International Sales since January 1999. In this position, Mr. Ramsey heads up the expansion of our international direct-sales and support teams and will complete the development of a worldwide channel organization. From April 1998 to January 1999, Mr. Ramsey was a Regional Field Sales Manager. From May 1989 to April 1998, Mr. Ramsey was employed with Ziff Davis Market Intelligence, where he was most recently the Vice President of Sales. Prior to working at Ziff Davis, Mr. Ramsey worked for IBM Corporation for five years. Mr. Ramsey received a B.S. in Communications from University of California, San Diego and an M.I.M. from American Graduate School of International Management. BOARD OF DIRECTORS AND COMMITTEES We have established an audit committee composed of Messrs. Doyle, Machin and Murdock. Messrs. Machin and Murdock are independent directors. This committee reviews and supervises our financial controls, including the selection of our auditors, reviews the books and accounts, meets with our officers regarding our financial controls, acts upon recommendations of auditors and takes further actions as the audit committee deems necessary to complete an audit of our books and accounts, as well as other matters which may come before it or as directed by the board. We have established a compensation committee, which reviews and approves the compensation and benefits for our executive officers, administers our stock plans and performs other duties as may from time 43 45 to time be determined by the board. The compensation committee is currently comprised of Messrs. Murdock and Machin. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION We did not have a Compensation Committee for 1998. In 1998, all decisions regarding executive compensation were made by our board of directors. We created our compensation committee in June 1999. In October 1997, we sold to Mr. Smith, our Chief Executive Officer and Chairman of the Board, 3,900,000 shares of common stock for aggregate consideration of $2.2 million. Mr. Smith executed a promissory note for the purchase price. This note is due and payable on April 1, 2002 and bears interest at a rate of 6.2%. The accrued interest on this note at 1999 fiscal year end was $326,251. As of the date of this prospectus, the entire principal amount of this note is outstanding. This note is also secured in part by the 3,900,000 shares of common stock. In April 1999, we purchased an aggregate of 14,820,000 shares of our common stock for a total purchase price of $35.0 million from trusts established by Mr. Machin, one of the founders and a director of Quest. In addition, we entered into a severance agreement with Mr. Machin pursuant to which we agreed to pay him an annual fee of $200,000 per year from 1999 to 2001, pay him medical benefits and provide for his use of a company car and related car expenses. Mr. Machin currently owns no shares of our capital stock. In April 1999, we sold an aggregate of 1,688,889 shares of our Series A Preferred Stock at a price of $5.625 per share to investors affiliated with InSight Capital Partners. The shares of Series A Preferred Stock converted into 2,533,333 shares of common stock immediately after our initial public offering. Mr. Murdock, a director of Quest, is a General Partner of InSight Capital Partners. Mr. Murdock has not been an officer or employee of ours at any time since our formation. No interlocking relationship exists between any of our executive officers or any member of our compensation committee and any member of any other company's board of directors or compensation committee. DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS Directors receive no cash remuneration for serving on the board of directors or any committee thereof. Non-employee directors are reimbursed for reasonable expenses incurred by them in attending board and committee meetings. Non-employee board members are also eligible for option grants pursuant to the provisions of the automatic option grant program under our 1999 Stock Incentive Plan. See "-- 1999 Stock Incentive Plan." 44 46 SUMMARY COMPENSATION TABLE The following table sets forth for the year ended December 31, 1997, 1998 and 1999, all compensation received for services rendered to Quest in all capacities by our chief executive officer and each of the other four most highly compensated executive officers whose salary and bonus exceeded $100,000 in 1999. These officers are referred to in this prospectus as the "Named Executive Officers." Does not include those individuals who would otherwise have been includable in such table on the basis of salary and bonus earned during 1997, 1998 and 1999 who have resigned or otherwise terminated his employment during 1997, 1998 and 1999. The compensation table excludes other compensation in the form of perquisites and other personal benefits that constitutes the lesser of $50,000 or 10% of the total annual salary and bonus earned by each of the Named Executive Officers in 1997, 1998 and 1999. The amount set forth in the "All Other Compensation" column includes matching contributions under our 401(k) Plan and expenses paid by us for car and the automobile insurance thereon. Additionally, the amount set forth in the "All Other Compensation" column paid to Mr. Aronoff include commissions associated with products purchased in the acquisition of R. Tech Systems, Inc.
LONG-TERM COMPENSATION ANNUAL COMPENSATION ------------------ --------------------- SECURITIES ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) UNDERLYING OPTIONS COMPENSATION($) - --------------------------- ---- --------- -------- ------------------ --------------- Vincent C. Smith................. 1999 $246,875 -- -- -- Chief Executive Officer 1998 191,666 $175,000 -- -- 1997 275,000 -- -- -- David M. Doyle................... 1999 246,875 -- -- $25,758 President 1998 200,000 175,000 -- -- 1997 273,854 -- -- -- John J. Laskey................... 1999 155,000 15,000 22,500 -- Chief Financial Officer 1998 -- -- 180,000 -- 1997 -- -- -- -- Eyal M. Aronoff.................. 1999 212,946 -- -- -- Vice President, Technology 1998 195,445 -- 39,000 -- and Engineering 1997 176,322 39,518 -- 38,397 Douglas F. Garn.................. 1999 194,500 125,000 -- -- Vice President, Worldwide Sales 1998 184,510 125,000 576,000 -- 1997 -- -- -- --
OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information with respect to stock options granted to each of the Named Executive Officers in 1999, including the potential realizable value over the ten-year term of the options, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These assumed rates of appreciation comply with the rules of the Commission and do not represent our estimate of future stock price. Actual gains, if any, on stock option exercises will be dependent on the future performance of our common stock. No stock appreciation rights were granted to the Named Executive Officers during 1999.
OPTIONS GRANTS IN 1999 ----------------------------------------------------- POTENTIAL REALIZABLE PERCENT OF VALUE AT ASSUMED ANNUAL NUMBER OF TOTAL RATES OF STOCK PRICE SECURITIES OPTIONS EXERCISE APPRECIATION FOR UNDERLYING GRANTED TO PRICE OPTION TERM($) OPTIONS EMPLOYEES IN PER-SHARE EXPIRATION ------------------------ NAME GRANTED(#) 1999(%) ($) DATE 5% 10% ---- ---------- ------------ --------- ---------- ---------- ---------- John J. Laskey....... 22,500 * $80.50 12/01/09 $1,669,715 $4,231,386
- ------------------------- * Less than one percent. The option listed in the table was granted under our 1999 Stock Incentive Plan, and represents the right to purchase one share of common stock. Except for 902 of Mr. Laskey's options, the options shown in this table are all nonqualified stock options. These options vest in full upon the one year anniversary of the grant date. 45 47 To the extent not already exercisable, all of these options will become exercisable in the event of a merger in which more than 50% of our outstanding securities are transferred to persons different from those persons who are our shareholders prior to the merger or upon the sale of substantially all our assets in complete liquidation or dissolution. This acceleration feature does not apply in the event that the options are assumed by the successor corporation in the merger or are replaced with a cash incentive program. During 1999 we granted options to purchase up to an aggregate of 2,391,125 shares of common stock. All options were granted at an exercise price equal to the fair market value of our common stock on the date of grant, as determined by our board of directors. The potential realizable value is calculated based on the ten year term of the option at its time of grant. It is calculated based on the assumption that the assumed public offering price of $118.00 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 1999.
NUMBER OF VALUE OF UNEXERCISED SECURITIES UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS AT OPTIONS AT DECEMBER 31, 1999 DECEMBER 31, 1999 ---------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Vincent C. Smith........................ -- -- -- -- David M. Doyle.......................... -- -- -- -- John J. Laskey.......................... 36,000 166,500 $ 3,629,880 $15,003,270 Eyal M. Aronoff......................... 10,920 28,080 $ 1,102,410 $ 2,834,040 Douglas F. Garn......................... 173,700 402,300 $17,543,700 $40,632,300
These values have been calculated on the basis of the fair market value of our common stock on December 31, 1999, less the applicable exercise price per share, multiplied by the number of shares underlying such options. 1999 STOCK INCENTIVE PLAN Introduction. Our 1999 Stock Incentive Plan is intended to serve as the successor equity incentive program to our 1998 Stock Option/Stock Issuance Plan. The 1999 Stock Incentive Plan was adopted by the board and subsequently approved by the shareholders in June 1999. The 1999 Stock Incentive Plan became effective upon its adoption by the board. On August 12, 1999, all outstanding options under our predecessor plan were incorporated into the 1999 Stock Incentive Plan, and no further option grants were made under the predecessor plan. The incorporated options will continue to be governed by their existing terms, unless the plan administrator elects to extend one or more features of the 1999 Incentive Plan to those options. Except as otherwise noted below, the incorporated options have substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve. 7,477,962 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan. This share reserve which was 2,210,320 at December 31, 1999 consists of the number of shares that remain available for issuance under the predecessor plan and shares of common stock subject to outstanding options thereunder. No participant in the 1999 Stock Incentive Plan may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances for more than 500,000 shares of common stock in total per calendar year. 46 48 Programs. The 1999 Stock Incentive Plan is divided into five separate programs: - the discretionary option grant program under which eligible individuals in Quest's employ may be granted options to purchase shares of common stock at an exercise price determined by the plan administrator; - the stock issuance program under which such individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - the salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - the automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - the director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration. The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the board of directors. This committee will determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the Federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The compensation committee will also have the authority to select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years. Plan Features. Our 1999 Stock Incentive Plan includes the following features: - The exercise price for any options granted under the plan may be paid in cash or in shares of common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. - The compensation committee will have the authority to cancel outstanding options under the discretionary option grant program in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date. - Stock appreciation rights may be issued under the discretionary option grant program. Such rights will provide the holders with the election to surrender their outstanding options for an appreciation distribution from us equal to the fair market value of the vested shares of common stock subject to the surrendered option less the exercise price payable for those shares. We may make the payment in cash or in shares of common stock. Change in Control. The 1999 Stock Incentive Plan includes the following change in control provisions which may result in the accelerated vesting of outstanding option grants and stock issuances: - In the event that Quest is acquired by merger or asset sale or a board-approved sale of more than fifty percent of the outstanding stock by our shareholders, each outstanding option under the discretionary option grant program which is not assumed or continued by the successor corporation will immediately become exercisable for all the option shares, and all unvested shares will 47 49 immediately vest, except to the extent we repurchase rights with respect to those shares are to be assigned to the successor corporation. - The plan administrator will have complete discretion to grant one or more options which will become exercisable for all the option shares in the event those options are assumed in the acquisition but the optionee's service with us or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than fifty percent (50%) of the outstanding voting stock or a change in the majority of our board of directors through one or more contested elections. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service. Salary Investment Option Grant Program. In the event the compensation committee decides to put this program into effect for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $75,000. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. A compensation expense will be recorded for the amount of the salary reduction. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control of Quest. Automatic Option Grant Program. Each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive an option grant for 25,000 shares on the date such individual joins the board, provided such individual has not been in the prior employ of Quest. In addition, on the date of each annual shareholders meeting beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 7,500 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of board service. The initial 25,000 share option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by us, at the exercise price paid per share, should the optionee cease board service prior to vesting in those shares. The shares subject to each 25,000 share automatic option grant will vest over a four (4) year period in successive equal annual installments upon the individual's completion of each year of board service over the four (4) year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of Quest or upon the optionee's death or disability while a board member. Each 7,500 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program. If this program is put into effect in the future, then each non-employee board member may elect to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be 48 50 made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares will be equal to the portion of the retainer fee invested in that option. The option will become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon certain changes in the ownership or control of Quest or the death or disability of the optionee while serving as a board member. Limited Stock Appreciation Rights. Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, salary investment option grant and director fee option grant programs and may be granted to one or more of our officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to Quest upon the successful completion of a hostile tender offer for more than 50% of the Quest outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from us in an amount per surrendered option share based on the highest price per share of common stock paid in connection with the tender offer. Amendment. The board may amend or modify the 1999 Stock Incentive Plan at any time, subject to any required shareholder approval. The 1999 Stock Incentive Plan will terminate no later than June 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction. The 1999 Employee Stock Purchase Plan was adopted by the board and approved by the shareholders in June 1999 and became effective on August 12, 1999. The 1999 Employee Stock Purchase Plan is designed to allow our eligible employees and the employees of our participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions under the 1999 Employee Stock Purchase Plan. Share Reserve. 600,000 shares of common stock have been reserved for issuance, of which 119,097 shares have been issued as of February 2, 2000. Purchase Periods. The plan has a series of successive purchase periods, each with a maximum duration of six months. The initial purchase period began on August 12, 1999 and ended on the last business day in January 2000. Thereafter, purchase periods run from the first business day in February to the last business day in July each year, and from the first business day in August to the last business day in January of the following year. Eligible Employees. Individuals who are scheduled to work more than 20 hours per week for more than 5 calendar months per year on the start date of any purchase period may join the plan on such start date. Payroll Deductions. A participant may contribute up to 15% of his or her cash earnings, and the accumulated payroll deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% of the fair market value of the common stock on the start date of the purchase period or, if lower, the fair market value on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of January and July each year. In no event, however, may any participant purchase more than 600 shares on any semi-annual purchase date. Change in Control. In the event Quest is acquired by merger or asset sale, all outstanding purchase rights will automatically be exercised immediately prior to the effective date of the acquisition. The purchase price will be equal to 85% of the fair market value per share of common stock on the 49 51 participant's entry date into the offering period in which such acquisition occurs or, if lower, the fair market value per share of common stock immediately prior to such acquisition. Termination/Amendment. The 1999 Employee Stock Purchase Plan will terminate on the last business day of July 2009. The board may at any time alter, suspend or discontinue the plan. However, certain amendments to the plan may require shareholder approval. Registration Statement on Form S-8. On November 22, 1999, we filed a registration statement on Form S-8 with the Commission pursuant to which we registered 7,493,400 shares of common stock issued or issuable upon exercise of options granted under the 1999 Stock Incentive Plan, 500,000 shares of common stock issuable under the 1999 Employee Stock Purchase Plan and 100,000 shares of common stock issuable under the International Employee Stock Purchase Plan. This registration statement became effective immediately upon filing. The possible sale of a significant number of such shares by the holders thereof may have an adverse effect on the price of our common stock. FOGLIGHT SOFTWARE, INC. 1998 STOCK OPTION PLAN In connection with the Foglight merger, we assumed the outstanding options issued under the Foglight Software, Inc. 1998 Stock Option Plan and reserved 25,602 shares of our common stock for issuance upon exercise of these assumed options. On February 4, 2000, we filed a registration statement on Form S-8 with the Commission pursuant to which we registered 25,602 shares of common stock issuable upon exercise of these assumed options. This registration statement became effective immediately upon filing. LIMITATION OF LIABILITY AND INDEMNIFICATION Our Amended and Restated Articles of Incorporation limit the personal liability of our directors for monetary damages to the fullest extent permitted by the California General Corporation Law. Under California law, a director's liability to a company or its shareholders may not be limited: - for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law; - for acts or omissions that a director believes to be contrary to the best interests of the company or its shareholders or that involve the absence of good faith on the part of the director; - for any transaction from which a director derived an improper personal benefit; - for acts or omissions that show a reckless disregard for the director's duty to the company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing the director's duties, of a risk of serious injury to the company or its shareholders; - for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the company or its shareholders; - under Section 310 of the California General Corporation Law concerning contacts or transactions between the company and a director; or - under Section 316 of the California General Corporation Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to our shareholders for any violation by a director of the director's fiduciary duty to us or our shareholders. Our Articles of Incorporation also include an authorization for us to indemnify our "agents," as defined in Section 317 of the California General Corporation Law, through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, our Amended and Restated Bylaws provide for indemnification of our directors, officers and employees. In addition, we may, at our 50 52 discretion, provide indemnification to persons whom we are not obligated to indemnify. The Amended and Restated Bylaws also allow us to enter into indemnity agreements with individual directors, officers, employees and other agents. Indemnity agreements have been entered into with all directors and certain executive officers and provide the maximum indemnification permitted by law. We also currently maintain directors' and officers' liability insurance. These agreements, together with our Amended and Restated Bylaws and Amended and Restated Articles of Incorporation, may require us, among other things, to indemnify our directors and executive officers, other than for liability resulting from willful misconduct of a culpable nature, and to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification. Section 317 of the California General Corporation Law and our Amended and Restated Bylaws and our indemnification agreements make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities, including reimbursement of expenses incurred, arising under the Securities Act. We are not currently aware of any pending litigation or proceeding involving any of our directors, officers, employees or agents in which indemnification will be required or permitted. Moreover, we are not currently aware of any threatened litigation or proceeding that might result in a claim for such indemnification. We believe that the foregoing indemnification provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. CERTAIN TRANSACTIONS SALES OF PREFERRED STOCK In April 1999, we sold an aggregate of 1,688,889 shares of our Series A Preferred Stock at a price of $5.625 per share to investors affiliated with InSight Capital Partners. Mr. Murdock, a director of Quest, is a General Partner of InSight Capital Partners. In April 1999 we also sold 977,778 shares of Series A Preferred Stock and 1,777,778 shares of our Series B Redeemable Preferred Stock to UBS Capital LLC at a price of $5.625 per share. The proceeds from the issuance of the Series A and Series B Preferred Stock was used to repurchase shares of our common stock held by Mr. Machin, one of our co-founders and directors. See "-- Repurchase of Shares from and Severance Arrangement with Director." Immediately after our initial public offering, all of the 2,666,667 shares of Series A Preferred Stock were converted into 4,000,000 shares of common stock. Such holders of shares of common stock issued upon the conversion of the Series A Preferred Stock are entitled to certain registration rights with respect to the common stock issued upon conversion thereof. See "Description of Capital Stock -- Registration Rights." We used approximately $10.6 million of the net proceeds of our initial public offering to redeem the Series B Redeemable Preferred Stock, including all accrued, cumulative dividends thereon. The following table summarizes the shares of preferred stock purchased by our executive officers, directors and five percent shareholders and persons associated with them since January 1996. The number of total shares on an as-converted basis reflects the 1-for-1.5 conversion ratio for each share of Series A Preferred Stock. The entities affiliated with InSight Capital Partners consist of InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P. and WI Software Investors LLC.
SERIES B SERIES A REDEEMABLE TOTAL SHARES ON AN PREFERRED PREFERRED AS-CONVERTED AGGREGATE INVESTOR STOCK STOCK BASIS CONSIDERATION - -------- --------- ---------- ------------------ ------------- Entities affiliated with InSight Capital Partners.................... 1,688,889 -- 2,533,333 $ 9,500,000 UBS Capital LLC....................... 977,778 1,777,778 1,466,667 15,500,000
51 53 REPURCHASE OF SHARES FROM AND SEVERANCE ARRANGEMENT WITH DIRECTOR In April 1999 we purchased an aggregate of 14,820,000 shares of our common stock for a total purchase price of $35.0 million from trusts established by Mr. Machin, one of the founders and a director of Quest. During late 1998, Mr. Machin sought to sell his stock and liquidate his position in Quest. Mr. Machin and the Company negotiated at arms-length to determine the pricing of the repurchase and Mr. Machin ultimately agreed upon a price based on the fact that he could obtain cash immediately. In addition, we entered into a severance agreement with Mr. Machin to pay him an annual fee of $200,000 per year from 1999 to 2001 and to provide for his use of a company car, related car expenses and medical benefits. There was no prior agreement that obligated us to consummate the repurchase transaction with Mr. Machin. Currently, Mr. Machin does not own any shares of our capital stock. ACQUISITION OF R*TECH SYSTEMS, INC. AND SALE OF STOCK TO OFFICER In March 1996, we acquired R*Tech Systems, Inc., the sole shareholder of which was Mr. Aronoff, our current Vice President, Engineering and Technology, through a merger of R*Tech with and into Quest. In the merger Quest issued 1,950,000 shares of common stock to Mr. Aronoff. Mr. Aronoff also entered into an employment agreement with us for a term of 24 months, under which he received an annual salary of $85,000, the right to receive commissions on the sale of certain products, the right to receive bonus payments of up to $400,000 upon the achievement of specified performance milestones, and an option to purchase up to 2.5% of our outstanding capital stock. In April 1998, Mr. Aronoff purchased 975,000 shares of common stock under the option for a per share purchase price of $.769 and a total purchase price of $750,000, for which Mr. Aronoff executed a promissory note. The note has a term of four years, bears interest at the rate of 5.7% per annum, and up to 25% of the original principal amount of the note may be prepaid in each year of the four-year term. The entire amount due under the note may be prepaid upon a sale or merger of Quest or at any time Mr. Smith no longer serves as our chief executive officer. During the year ended December 31, 1999, Mr. Aronoff made principal payments on the note of $230,000. The accrued interest on this note at 1999 fiscal year end was $68,984. Mr. Aronoff's two-year employment agreement expired in March 1998. SALE OF COMMON STOCK TO MR. SMITH In October 1997, we sold to Mr. Smith, our Chief Executive Officer, 3,900,000 shares of common stock for aggregate consideration of $2.2 million. Mr. Smith executed a promissory note for the purchase price. See "Management -- Compensation Committee Interlocks and Insider Participation." TRANSACTIONS WITH DIRECTORS AND OFFICERS In June 1998, we granted options to two of our officers, Eyal Aronoff and Douglas Garn, to purchase 24,000 and 450,000 shares of our common stock, respectively, at an exercise price of $1.00 per share. In July 1998, we granted options to Mr. Garn and Terence Mullin and Charles Ramsey, officers, to purchase 126,000, 75,000 and 150,000 shares of our common stock, respectively, at an exercise price of $1.00. In September 1998, we granted options to Mr. Aronoff and to John Laskey, an officer, to purchase 15,000 and 180,000 shares of our common stock, respectively, at an exercise price of $1.17 per share. In January 1999, we granted options to purchase 120,000 shares of our common stock at an exercise price of $2.37 per share to Carla Fitzgerald, an officer. In January 1999, we granted options to purchase 30,000 and 15,000 shares of our common stock at an exercise price of $2.37 per share to Mr. Mullin and Mr. Ramsey, respectively. In December 1999, we granted options to purchase 22,500 shares of our common stock at an exercise price of $80.50 per share to Mr. Laskey. 52 54 OTHER RELATED PARTY TRANSACTIONS We have entered into an indemnification agreement with certain of our executive officers and our directors containing provisions that may require us, among other things, to indemnify our officers and our directors against certain liabilities that may arise by reason of their status or service as officers or directors, other than liabilities arising from willful misconduct of a culpable nature, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. See "Management -- Limitation of Liability and Indemnification." We believe that all of the transactions set forth above were made on terms no less favorable to us than could have been otherwise obtained from unaffiliated third parties. All future transactions, including loans, if any, between us and our officers, directors and principal shareholders and their affiliates and any transactions between us and any entity with which our officers, directors or principal shareholders are affiliated will be approved by a majority of the board of directors, including a majority of the independent and disinterested outside directors of the board of directors and will be on terms no less favorable to us than could be obtained from unaffiliated third parties. PRINCIPAL AND SELLING SHAREHOLDERS The table below sets forth information regarding the beneficial ownership of our common stock as of February 16, 2000 by the following individuals or groups: - each person or entity who is known by Quest to own beneficially more than five percent of our outstanding common stock; - each of the Named Executive Officers; - each director; - all directors and executive officers as a group, which for us is seven persons; and - the selling shareholders. Applicable percentage ownership in the following table is based on the number of shares of common stock outstanding as of February 16, 2000. In addition, information presented in the table below assumes no exercise of the underwriters' over-allotment option. Beneficial ownership is determined in accordance with the rules of the Commission and generally includes voting or investment power with respect to securities. The number of shares beneficially owned and the percentage of shares beneficially owned are based on 40,403,018 shares of common stock outstanding as of February 16, 2000 and 42,461,122 shares of common stock outstanding upon consummation of this offering assuming the over-allotment option is exercised and that all the additional shares will be sold by the selling shareholders. Shares of common stock subject to options currently exercisable or exercisable within 60 days of February 16, 2000 are deemed to be outstanding and to be beneficially owned by the person holding these options for the purpose of computing the number of shares beneficially owned and the percentage of the person or entity holding these securities, but are not deemed outstanding for the purpose of computing the percentage ownership of any other person or entity. Unless otherwise indicated, the principal address of each of the shareholders below is c/o Quest Software, Inc., 8001 Irvine Center Drive, Irvine, California 92618.
NUMBER OF SHARES NUMBER OF SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THIS OFFERING AFTER THIS OFFERING ----------------------- SHARES TO ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE ------------------------ ---------- ---------- --------- ---------- ---------- Vincent C. Smith(1)................. 18,084,174 44.8% 50,000 18,034,174 42.5% David M. Doyle...................... 7,250,657 17.9 350,000 6,900,657 16.3 Eyal M. Aronoff(2).................. 2,940,990 7.3 250,000 2,690,990 6.3 Jerry Murdock(3).................... 2,785,201 6.9 50,000 2,735,201 6.4
53 55
NUMBER OF SHARES NUMBER OF SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THIS OFFERING AFTER THIS OFFERING ----------------------- SHARES TO ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE ------------------------ ---------- ---------- --------- ---------- ---------- John J. Laskey(4)................... 59,400 * 36,000 23,400 * Douglas F. Garn(5).................. 248,580 * 60,000 188,580 * Doran G. Machin..................... InSight Capital Partners(7)......... 2,520,001 6.2 0 2,520,001 6.1 UBS Capital LLC(8).................. 1,466,667 3.6 170,000 1,296,667 3.1 WI Software Investors, LLC.......... 1,200,000 3.0 750,000 450,000 1.4 Hillrich Client Plan Ltd. .......... 500,000 1.2 125,000 375,000 1.0 Mohr Davidow Ventures IV, L.P....... 253,728 * 126,864 126,864 * Daniel Benveniste(9)................ 9,697 * 3,800 5,897 * Gal Bar-Or.......................... 145,471 * 29,094 116,377 * Robert Fanini....................... 143,762 * 43,129 100,633 * James Jordan........................ 104,539 * 41,816 62,723 * Daniel Callahan..................... 88,274 * 17,655 70,619 * Weiss Peck & Greer Venture Associates IV, L.L.C.............. 77,091 * 38,545 38,546 * WPG Enterprise Fund III, L.L.C...... 68,195 * 34,097 34,098 * Westpool Investment Trust........... 44,540 * 22,270 22,270 * Lion Investments Limited............ 44,094 * 22,047 22,047 * Dennis Blay(10)..................... 16,942 * 930 16,012 * MDV IV Entrepreneurs' Network Fund, L.P............................... 13,350 * 6,675 6,675 * Weiss Peck & Greer Venture Associates IV, Cayman, L.P........ 9,839 * 4,919 4,920 * Roger Tharp(11)..................... 7,636 * 500 7,136 * WPG Information Sciences Enterpreneur Fund, L.P............ 3,062 * 1,531 1,531 * Joseph Hnilo(12).................... 1,504 * 300 1,204 * Weber Family Trust.................. 443 * 223 220 * All other selling shareholders together beneficially own less than 1% of the total outstanding shares prior to this offering (29 persons).......................... 210,487 * 60,375 150,112 * All executive officers and directors as a group (7 persons)(6)......... 31,369,002 77.1 796,000 30,573,002 71.5
- ------------------------- * Less than 1%. (1) Includes 38,100 shares held in the name of McNair Smith and 38,100 shares held in the name of McKenzie Smith, Mr. Smith's minor children. Includes 50,000 shares of common stock held by the Vincent C. Smith Charitable Remainder Unitrust, of which Mr. Smith is the trustee and which is participating as a selling shareholder in this offering. Mr. Smith may sell up to the entire 630,000 shares of common stock if the underwriters exercise their over-allotment option in full. (2) Includes 4,224 shares held in the name of Aely Sollie Aronoff and 17,223 shares held in the name of Leya Jullie Aronoff, Mr. Aronoff's minor children. Also includes 15,990 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. (3) Includes 265,200 shares of common stock owned directly by Mr. Murdock. Also includes 1,188,000 shares of common stock held by InSight Capital Partners II, L.P., 132,001 shares of common stock held by InSight Capital Partners (Cayman) II, L.P., and 1,200,000 shares of common stock held by WI Software Investors LLC. Mr. Murdock is a General Partner of InSight Capital Partners and a 54 56 director of Quest. Mr. Murdock disclaims beneficial ownership of the shares held by InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., and WI Software Investors LLC, except to the extent of his indirect pecuniary interests therein. (4) Consists of 59,400 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. (5) Consists of 248,580 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. (6) Consists of 323,970 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. See Notes 2, 4 and 5. See also Notes 1 and 3. (7) Includes 132,001 shares of common stock held by InSight Capital Partners (Cayman) II, L.P., 1,188,000 shares of common stock held by InSight Capital Partners II, L.P., and 1,200,000 shares of common stock held by WI Software Investors LLC. InSight Capital Partners II, L.P. is a limited partnership controlled by its general partner, InSight Venture Associates II, LLC, which has voting and dispositive powers over its shares of Series A Preferred Stock. InSight Capital Partners (Cayman) II, L.P. is a limited partnership controlled by its general partner, InSight Venture Associates (Cayman) II, a Cayman Island company, which has voting and dispositive powers over its shares of Series A Preferred Stock. The managing members of InSight Venture Associates II, LLC and InSight Venture Associates (Cayman) II are Jeff Horing, Jerry Murdock and Ramanan Raghavendran. (8) UBS is a limited liability company controlled by a board of managers who have voting and dispositive powers over UBS' shares of common stock. The board of managers consists of Justin Maccarone, Michael Green and Marc Unger. (9) Includes 1,071 shares of common stock which are subject to our right of repurchase which lapses on April 28, 2003. Also includes 15,517 shares of common stock which are subject to an escrow which expires of October 7, 2000. (10) Includes 7,875 shares of common stock which are subject to our right of repurchase which lapses on June 24, 2003. Also includes 1,694 shares of common stock which are subject to an escrow which expires on October 7, 2000. (11) Includes 3,056 shares of common stock which are subject to our right of repurchase which lapses on April 28, 2003. Also includes 764 shares of common stock which are subject to an escrow which expires on October 7, 2000. (12) Includes 11,282 shares of common stock which are subject to our right of repurchase which lapses on May 13, 2003. Also includes 1,504 shares of common stock which are subject to an escrow which expires on October 7, 2000. 55 57 DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of 75,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock. The following description of our capital stock is subject to and qualified by our Amended and Restated Articles of Incorporation and Bylaws and by the provisions of applicable California law. COMMON STOCK As of December 31, 1999, there were 38,905,344 shares of common stock outstanding held of record by 59 shareholders, and options to purchase an aggregate of 5,255,807 shares of common stock were also outstanding. There will be 40,809,574 shares of common stock outstanding, assuming no exercise of the underwriters' option to purchase additional shares, additional issuances of shares of common stock in connection with acquisitions after December 31, 1999, exercise of outstanding options under the stock plans after December 31, 1999 or exercise of warrants outstanding after the closing of this offering, after giving effect to the sale of the shares of common stock to the public offered in this prospectus. The holders of common stock are entitled to one vote per share on all matters to be voted upon by the shareholders. Subject to preferences that may be applicable to any outstanding preferred stock that may come into existence, the holders of common stock are entitled to receive ratably those dividends, if any, as may be declared from time to time by the board of directors out of funds legally available for dividends. See "Dividend Policy." In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock then outstanding, if any. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable, and the shares of common stock to be outstanding upon completion of this offering will be fully paid and nonassessable. PREFERRED STOCK Our board of directors is authorized, without further shareholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of such series. We have no present plans to issue any shares of preferred stock. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Any series of preferred stock may possess voting, dividend, liquidation and redemption rights superior to that of the common stock. Issuance of a new series of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of entrenching our board of directors and making it more difficult for a third party to acquire, or discourage a third party from acquiring, a majority of our outstanding voting stock. We have no present plans to issue any shares of or designate any series of preferred stock. We believe that the ability to issue preferred stock without the expense and delay of a special shareholders' meeting will provide us with increased flexibility in structuring possible future financings and acquisitions, and in meeting other corporate needs that might arise. This also permits the board of directors to issue preferred stock containing terms which could impede the completion of a takeover attempt, subject to certain limitations imposed by the securities laws. The board of directors will make any determination to issue such shares based on its judgment as to the best interests of Quest and our shareholders at the time of issuance. This could discourage an acquisition attempt or other transaction which shareholders might believe to be in their best interests or in which they might receive a premium for their stock over the then market price of the stock. 56 58 REGISTRATION RIGHTS The holders of an aggregate of 4,000,000 shares of common stock are entitled to certain rights with respect to the registration of such shares under the Securities Act. Under the terms of the registration rights agreements, if we propose to register any of our securities under the Securities Act, either for our own account or for the account of other security holders exercising registration rights, these holders are entitled to notice of such registration and are entitled to include shares of common stock in the registration. The rights are subject to conditions and limitations, among them the right of the underwriters of an offering subject to the registration to limit the number of shares included in such registration. Holders of these rights may also require us to file a registration statement under the Securities Act at our expense with respect to their shares of common stock, and we are required to use our best efforts to effect such registration, subject to certain conditions and limitations. Furthermore, shareholders with registration rights may require us to file additional registration statements on Form S-3, subject to conditions and limitations. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is U.S. Stock Transfer Corporation. LISTING Our common stock is quoted on the Nasdaq National Market under the trading symbol "QSFT." 57 59 SHARES ELIGIBLE FOR FUTURE SALE Future sales of substantial amounts of common stock, including shares issued upon exercise of outstanding options or warrants, in the public market could adversely affect prevailing market prices from time to time. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of certain contractual and legal restrictions on resale, as described below, sales of substantial amount of common stock in the public market after the restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of this offering, we will have 40,809,574 shares of common stock outstanding assuming the issuance of 1,904,230 shares of common stock offered, no exercise of the underwriters' over-allotment option, no exercise of outstanding stock options after December 31, 1999 and no issuances of additional shares of common stock in connection with acquisitions after December 31, 1999. Of the total outstanding shares of common stock, the 4,200,000 shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, except that any shares purchased by our "affiliates," as that term is defined in Rule 144 under the Securities Act, may generally only be sold pursuant to an effective registration statement under the Securities Act or in compliance with the limitations of Rule 144 as described below. In addition, the 5,060,000 shares of common stock that we sold in our initial public offering are freely tradeable. 31,728,589 shares of common stock are "restricted securities" as that term is defined in Rule 144, 820,500 shares are freely tradeable under Rule 144(k) 5,061,200 shares may be freely sold pursuant to Registration Statements on Form S-8, and 33,873 shares may be sold pursuant to Rule 701. All of these restricted securities, 144(k) shares, S-8 shares and Rule 701 shares will be available for sale in the public market following the expiration of the 90 day lock-up agreement further described below. If the underwriter elects to waive the lock-up period for any reason, these shares will be available for sale under Rule 144, Rule 144(k), Rule 701 or pursuant to Form S-8 prior to that time. The holders of 4,000,000 restricted shares are entitled to certain rights with respect to registration of these shares for sale in the public market. Registration of such shares under the Securities Act would result in such shares becoming freely tradeable without restriction under the Securities Act, except for shares purchased by our affiliates. If these holders sell in the public market these sales would have a material adverse effect on the market price of the common stock. Certain of these shares will be sold in this offering. Quest, our officers, directors, shareholders, and most of our optionholders have entered into contractual "lock-up" agreements generally providing that, subject to certain limited exceptions, they will not offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any of the shares of common stock or any securities convertible into, or exercisable or exchangeable for, common stock owned by them, or enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock, for a period of 90 days after the date of this prospectus, without the prior written consent of FleetBoston Robertson Stephens Inc., except that we may, without such consent, grant options and sell shares pursuant to our stock plans. FleetBoston Robertson Stephens Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. FleetBoston Robertson Stephens Inc. currently has no plans to release any portion of the securities subject to lock-up agreements. When determining whether or not to release shares from the lock-up agreements, FleetBoston Robertson Stephens Inc. will consider, among other factors, the shareholder's reasons for requesting the release, the number of shares for which the release is being requested and market conditions at the time. Following the expiration of the 90-day lock-up period, the restricted securities will be available for sale in the public market subject to compliance with Rule 144 or Rule 701. 58 60 In general, under Rule 144 as currently in effect, any affiliate of ours or a person, or persons whose shares are aggregated, who has beneficially owned restricted shares for at least one year, including the holding period of any prior owner other than a person who may be deemed an affiliate of ours, is entitled to sell within any three-month period a number of shares of common stock that does not exceed the greater of: - one percent of the then-outstanding shares of common stock (approximately 408,095 shares after giving effect to this offering); and - the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a Form 144 notice with respect to this sale. Sales under Rule 144 of the Securities Act are subject to certain restrictions relating to manner of sale, notice and the availability of current public information about us. Under Rule 144(k), a person who is not an affiliate of ours at any time during the 90 days preceding a sale, and who has beneficially owned shares for at least two years, including the holding period of any prior owner other than a person who may be deemed an affiliate of ours, would be entitled to sell these shares immediately following this offering without regard to the volume limitations, manner of sale provisions or notice or other requirements of Rule 144 of the Securities Act. However, the transfer agent may require an opinion of counsel that a proposed sale of shares comes within the terms of Rule 144 of the Securities Act prior to effecting a transfer of these shares. We are unable to estimate the number of shares that will be sold under Rule 144, as this will depend on the market price for our common stock, the personal circumstances of the sellers and other factors. There can be no assurance that a significant public market for our common stock will develop or be sustained after this offering. Any future sale of substantial amounts of common stock in the open market may adversely affect the market price of the common stock offered hereby. On November 22, 1999, we filed a Form S-8 registration statement under the Securities Act registering all shares of common stock issuable under the 1999 Stock Incentive Plan and the Employee Stock Purchase Plan. On February 4, 2000, we filed a Form S-8 registration statement registering all shares of common stock issuable upon exercise of outstanding options which we assumed in connection with the Foglight merger. Such registration statements became effective immediately upon filing, and shares covered by the registration statements are eligible for sale in the public markets, subject to any lock-up agreements applicable thereto and Rule 144 limitations applicable to affiliates. See "Management -- 1999 Employee Stock Purchase Plan," "Management -- Foglight Software, Inc. 1998 Stock Option Plan," "Description of Capital Stock -- Registration Rights" and "Underwriting." 59 61 UNDERWRITING The underwriters named below, acting through their representatives, FleetBoston Robertson Stephens Inc., Chase Securities Inc., Donaldson, Lufkin & Jenrette Securities Corporation, CIBC World Markets Corp., SoundView Technology Group, Inc. 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 - ----------- --------- FleetBoston Robertson Stephens Inc. ........................ Chase Securities Inc. ...................................... Donaldson, Lufkin & Jenrette Securities Corporation ........ CIBC World Markets Corp. ................................... SoundView Technology Group, Inc. ........................... First Albany Corporation.................................... --------- Total............................................. 4,200,000 =========
We have been advised by the Representatives that the underwriters propose to offer the shares of common stock to the public at the initial public offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession of not in excess of $ per share, of which $ may be reallowed to other dealers. After the initial public offering, the initial public offering price, concession and reallowance to dealers may be reduced by the Representatives. No such reduction shall change the amount of proceeds to be received by us as set forth on the cover page of this prospectus. The common stock is offered by the underwriters as stated herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. Over-Allotment Option Certain selling shareholders and/or we have granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to 630,000 additional shares of common stock at the same price per share as we will receive for the 4,200,000 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 4,200,000 shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 4,200,000 shares are being sold. We and/or certain selling shareholders 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, and assuming that all of the additional shares will be sold by selling shareholders, the total public offering price, underwriting discounts and commissions and proceeds, before expenses, will be $569,940,000, $22,302,000 and $547,638,000, respectively. Indemnity The underwriting agreement contains covenants of indemnity among the underwriters and us against certain civil liabilities, including liabilities under the Securities Act and liabilities arising from breaches of representations and warranties contained in the underwriting agreement. 60 62 Lock-Up Agreements Each of our executive officers, directors and shareholders and substantially all of our optionholders have agreed with the Representatives, for a period of 90 days after the date of this prospectus, subject to certain exceptions, not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any shares of common stock, any options or warrants to purchase any shares of common stock, or any securities convertible into or exchangeable for shares of common stock owned as of the date of this prospectus or, with certain exceptions, thereafter acquired directly by such holders or with respect to which they have or hereafter acquire the power of disposition, without the prior written consent of FleetBoston Robertson Stephens Inc. However, FleetBoston Robertson Stephens Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to the lock-up agreements. There are no agreements between the Representatives and any of our shareholders providing consent by the Representatives to the sale of shares prior to the expiration of the period of 90 days after this prospectus. Future Sales In addition, we have agreed that during the period of 90 days after this prospectus, we will not, subject to certain exceptions, without the prior written consent of FleetBoston Robertson Stephens Inc.: - Consent to the disposition of any shares held by shareholders prior to the expiration of the period of 90 days after this prospectus; or - Issue, sell, contract to sell or otherwise dispose of, any shares of common stock, any options or warrants to purchase any shares of common stock or any securities convertible into, exercisable for or exchangeable for shares of common stock. Electronic Prospectus A prospectus in electronic format is being made available on an Internet web site maintained by Wit Capital Corporation, an affiliate of SoundView Technology Group, Inc. Other than the prospectus in electronic format, the information on Wit Capital Corporation's web site and any information contained on any other web site maintained by any dealer is not part of this prospectus or the registration statement of which this prospectus forms a part, has not been approved and/or endorsed by us or any underwriter in its capacity as underwriter and should not be relied upon by investors. Stabilization The Representatives have advised us that, pursuant to Regulation M under the Securities Act, certain persons participating in this offering may engage in transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids, that may have the effect of stabilizing or maintaining the market price of the common stock at a level above that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of the common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of the common stock. A "syndicate covering transaction" is the bid for or the purchase of the common stock on behalf of the underwriters to reduce a short position incurred by the underwriters in connection with this offering. A "penalty bid" is an arrangement permitting the Representatives to reclaim the selling concession otherwise accruing to an underwriter or syndicate member in connection with this offering if the common stock originally sold by such underwriter or syndicate member is purchased by the Representatives in a syndicate covering transaction and has therefore not been effectively placed by such underwriter or syndicate member. The Representatives have advised us that such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. 61 63 LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Brobeck, Phleger & Harrison LLP, Irvine, California. Certain members and individuals associated with Brobeck, Phleger & Harrison LLP own an aggregate of 5,300 shares of our common stock. Certain legal matters in connection with the offering will be passed upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. EXPERTS The Consolidated Financial Statements of Quest Software, Inc. as of December 31, 1998 and 1999 and for each of the three years in the period ended December 31, 1999 included in this prospectus, the related financial statement schedule included elsewhere in the registration statement, and the financial statements of Foglight Software, Inc. as of December 31, 1999 and for the year then ended have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports appearing herein and elsewhere in the registration statement, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing. The financial statements of MBR Technologies, Inc. as of March 31, 1999 and for the period from April 23, 1998 (inception) to March 31, 1999 included in this prospectus and registration statement have been audited by Swenson Advisors, LLP, independent auditors, as stated in their report, which we have included in this prospectus and registration statement and is given upon the authority of Swenson Advisors, LLP, as experts in accounting and auditing. The financial statements as of Foglight Software, Inc. as of December 31, 1998 and for the period from November 10, 1997 (date of inception) to December 31, 1998 included in this Prospectus and registration statement have been so included in reliance on the report, which contains an explanatory paragraph relating to the Company's ability to continue as a going concern as described in Note 1 to the financial statements, of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. ADDITIONAL INFORMATION We have filed with the Securities and Exchange Commission, Washington, D.C. 20549 (the "Commission"), under the Securities Act, as amended, a registration statement on Form S-1 relating to the common stock offered. This prospectus does not contain all of the information set forth in the registration statement and its exhibits and schedules. For further information with respect to us and the shares we are offering pursuant to this prospectus you should refer to the registration statement, including its exhibits and schedules. Statements contained in this prospectus as to the contents of any contract, agreement or other document referred to are materially complete, and you should refer to the copy of that contract or other document filed as an exhibit to the registration statement or any other document. You may inspect a copy of the registration statement without charge at the Public Reference Section of the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 or at the Commission's regional offices at 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036. The Commission maintains an Internet site that contains reports, proxy information statements and other information regarding registrants that file electronically with the Commission. The Commission's World Wide Web address is www.sec.gov. We intend to furnish holders of our common stock with annual reports containing, among other information, audited consolidated financial statements certified by an independent public accounting firm and quarterly reports containing unaudited condensed financial information for the first three quarters of each fiscal year. We intend to furnish these other reports as we may determine or as may be required by law. 62 64 INDEX TO FINANCIAL STATEMENTS
PAGE ---- QUEST SOFTWARE, INC. Independent Auditors' Report.............................. F-2 Consolidated Balance Sheets as of December 31, 1998 and 1999................................................... F-3 Consolidated Statements of Income for the Years Ended December 31, 1997, 1998 and 1999....................... F-4 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1998 and 1999........... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999....................... F-6 Notes to Consolidated Financial Statements................ F-7 MBR TECHNOLOGIES, INC. Report of Independent Auditors............................ F-24 Balance Sheets as of March 31, 1999 and December 17, 1999 (Unaudited)............................................ F-25 Statements of Operations From Inception (April 23, 1998) Through March 31, 1999 and for the Period From January 1, 1999 to December 17, 1999 (Unaudited)............... F-26 Statements of Shareholders' Equity From Inception (April 23, 1998) Through March 31, 1999 and the Period From April 1, 1999 to December 17, 1999 (Unaudited)......... F-27 Statements of Cash Flows From Inception (April 23, 1998) Through March 31, 1999 and the Period From January 1, 1999 to December 17, 1999 (Unaudited).................. F-28 Notes to Financial Statements............................. F-29 FOGLIGHT SOFTWARE, INC. Report of Independent Accountants......................... F-32 Balance Sheet as of December 31, 1998..................... F-33 Statement of Operations for the Period November 10, 1997 (Date of Inception) to December 31, 1998...................................... F-34 Statement of Stockholders' Deficit for the Period November 10, 1997 (Date of Inception) to December 31, 1998...... F-35 Statement of Cash Flows for the Period November 10, 1997 (Date of Inception) to December 31, 1998............... F-36 Notes to Financial Statements............................. F-37 Independent Auditors' Report.............................. F-47 Balance Sheet as of December 31, 1999..................... F-48 Statement of Operations for the Year Ended December 31, 1999................................................... F-49 Statement of Capital Deficiency for the Year Ended December 31, 1999...................................... F-50 Statement of Cash Flows for the Year Ended December 31, 1999................................................... F-51 Notes to Audited Financial Statements..................... F-52 UNAUDITED PRO FORMA INFORMATION Unaudited Pro Forma Information........................... F-62 Balance Sheet as of December 31, 1999..................... F-63 Statements of Operations for the Year Ended December 31, 1999................................................... F-64 Notes to Pro Forma Financial Statements................... F-65
F-1 65 INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors Quest Software, Inc. We have audited the accompanying consolidated balance sheets of Quest Software, Inc. and subsidiaries (the Company) as of December 31, 1998 and 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Quest Software, Inc. and its subsidiaries at December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 1, 2000 (except for Note 12 as to which the date is February 11, 2000) F-2 66 QUEST SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, ------------------- 1998 1999 ------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 8,981 $ 39,643 Short-term marketable securities, available for sale...... -- 11,000 Accounts receivable, net of allowance for doubtful accounts and sales returns of $1,052 (1998) and $3,239 (1999)................................................. 7,443 18,771 Prepaid expenses and other current assets................. 720 3,244 Deferred income taxes..................................... 198 2,089 ------- -------- Total current assets................................. 17,342 74,747 Property and equipment, net................................. 1,388 7,179 Long-term marketable securities, available for sale......... -- 4,484 Purchased technology and software licenses, net............. 527 441 Goodwill, net............................................... -- 11,452 Deferred income taxes....................................... 267 415 Other assets................................................ 121 431 ------- -------- $19,645 $ 99,149 ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 1,468 $ 3,436 Accrued compensation...................................... 1,937 4,966 Other accrued expenses.................................... 2,243 7,062 Income taxes payable...................................... -- 2,030 Deferred support revenue.................................. 7,298 13,932 Deferred license revenue.................................. 1,625 4,651 ------- -------- Total current liabilities............................ 14,571 36,077 Long-term liabilities....................................... -- 403 Commitments and contingencies (Note 9) Shareholders' equity: Preferred stock, no par value, 5,000 shares authorized; no shares issued or outstanding........................... -- -- Common stock, no par value, 75,000 shares authorized; 44,538 and 38,905 shares issued and outstanding at December 31, 1998 and 1999............................. 4,241 94,010 Retained earnings........................................... 3,991 1,864 Accumulated other comprehensive income (loss)............... -- (26) Notes receivable from sale of common stock.................. (3,158) (3,115) Capital distribution in excess of basis in common stock..... -- (30,064) ------- -------- Total shareholders' equity........................... 5,074 62,669 ------- -------- $19,645 $ 99,149 ======= ========
See accompanying notes to consolidated financial statements. F-3 67 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ----------------------------------------- 1997 1998 1999 ----------- ----------- ----------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Revenues: Licenses.................................................. $12,158 $24,901 $54,269 Services.................................................. 6,157 9,889 16,599 ------- ------- ------- Total revenues....................................... 18,315 34,790 70,868 Cost of revenues: Licenses.................................................. 1,307 3,433 2,998 Services.................................................. 1,972 2,507 4,195 ------- ------- ------- Total cost of revenues............................... 3,279 5,940 7,193 ------- ------- ------- Gross profit................................................ 15,036 28,850 63,675 Operating expenses: Sales and marketing....................................... 5,845 11,836 32,078 Research and development.................................. 4,293 8,047 15,980 General and administrative................................ 3,450 5,278 9,906 Other compensation costs and goodwill amortization........ -- -- 1,243 ------- ------- ------- Total operating expenses............................. 13,588 25,161 59,207 ------- ------- ------- Income from operations...................................... 1,448 3,689 4,468 Other (expense) income, net................................. (137) 336 1,202 ------- ------- ------- Income before income tax provision.......................... 1,311 4,025 5,670 Income tax provision........................................ 1,022 1,679 2,273 ------- ------- ------- Net income.................................................. $ 289 $ 2,346 3,397 ======= ======= Preferred stock dividends................................... 590 ------- Net income applicable to common shareholders................ $ 2,807 ======= Basic and diluted net income per share...................... $ 0.01 $ 0.05 $ 0.07 Weighted average shares: Basic..................................................... 40,373 44,261 37,677 Diluted................................................... 40,617 44,459 41,800
See accompanying notes to consolidated financial statements. F-4 68 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
CAPITAL DISTRIBUTION ACCUMULATED NOTES IN EXCESS OF COMMON STOCK OTHER RECEIVABLE BASIS IN TOTAL ------------------ RETAINED COMPREHENSIVE FROM COMMON SHAREHOLDERS' SHARES AMOUNT EARNINGS INCOME (LOSS) SHAREHOLDERS STOCK EQUITY -------- ------- -------- ------------- ------------ ------------ ------------- BALANCE, January 1, 1997..... 39,000 $ 812 $ 1,617 $ -- $ -- $ -- $ 2,429 Issuance of common stock..... 597 413 -- -- -- -- 413 Note receivable from shareholder for purchase of common stock............... 3,900 2,200 -- -- (2,200) -- -- Accrued interest receivable from shareholder........... -- -- -- -- (34) -- (34) Net income................... -- -- 289 -- -- -- 289 Distributions paid........... -- -- (261) -- -- -- (261) -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1997... 43,497 3,425 1,645 -- (2,234) -- 2,836 Issuance of common stock..... 66 66 -- -- -- -- 66 Note receivable from shareholder for purchase of common stock............... 975 750 -- -- (750) -- -- Accrued interest receivable from shareholders.......... -- -- -- -- (174) -- (174) Net income................... -- -- 2,346 -- -- -- 2,346 -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1998... 44,538 4,241 3,991 -- (3,158) -- 5,074 -------- ------- ------- ---- ------- -------- -------- Exercise of stock options, including tax benefit...... 34 201 -- -- -- -- 201 Payment on notes receivable from shareholders for purchase of common stock... -- -- -- -- 230 -- 230 Accrued interest receivable from shareholders.......... -- -- -- -- (187) -- (187) Repurchase of common stock... (14,820) (2) (4,934) -- -- (30,064) (35,000) Conversion of Series A Redeemable Preferred Stock to common stock............ 4,000 15,000 -- -- -- -- 15,000 Issuance of common stock in the initial public offering, net.............. 5,060 64,856 -- -- -- -- 64,856 Compensation expense associated with stock option grants.............. -- 432 -- -- -- -- 432 Common stock issued for an acquisition, net (Note 2)......................... 93 9,282 -- -- -- -- 9,282 Dividends on Series B Redeemable Preferred Stock...................... -- -- (590) -- -- -- (590) Unrealized loss on available-for-sale securities................. -- -- -- (26) -- -- (26) Net income................... -- -- 3,397 -- -- -- 3,397 -------- Comprehensive income......... -- -- -- -- -- -- 3,371 -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1999... 38,905 $94,010 $ 1,864 $(26) $(3,115) $(30,064) $ 62,669 ======== ======= ======= ==== ======= ======== ========
See accompanying notes to consolidated financial statements. F-5 69 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1998 1999 ------- -------- -------- Cash flows from operating activities: Net income................................................ $ 289 $ 2,346 $ 3,397 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......................... 964 1,893 2,107 Compensation expense associated with stock option grants............................................... -- -- 432 Loss from disposal of property and equipment.......... 52 -- -- Accrued interest receivable from shareholders......... (34) (174) (187) Deferred income taxes................................. 178 (643) (1,667) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable................................ (683) (2,628) (11,441) Income taxes receivable............................ (122) 122 -- Prepaid expenses and other current assets.......... 282 (620) (2,527) Other assets....................................... 38 5 (288) Accounts payable................................... 113 941 1,974 Bank overdraft..................................... (393) -- -- Accrued compensation............................... 108 1,162 2,544 Other accrued expenses............................. 881 1,141 5,366 Income taxes payable............................... -- -- 2,218 Deferred revenue................................... 1,960 4,636 9,449 ------- -------- -------- Net cash provided by operating activities.......... 3,633 8,181 11,377 Cash flows from investing activities: Purchases of property and equipment....................... (536) (1,231) (7,143) Purchases of software licenses............................ (831) (57) (350) Cash received (paid) for acquisitions, net of cash acquired................................................ 100 -- (1,094) Purchases of marketable securities........................ -- -- (15,510) Sales and maturities of marketable securities............. -- -- -- ------- -------- -------- Net cash used in investing activities.............. (1,267) (1,288) (24,097) Cash flows from financing activities: Distributions to shareholders............................. (261) -- -- Proceeds from note payable................................ -- -- 10,000 Repayment of notes payable................................ -- -- (10,918) Repayment of capital lease obligations.................... -- -- (36) Proceeds from issuance of preferred stock................. -- -- 25,000 Redemption of Series B Preferred Stock.................... -- -- (10,000) Repurchase of common stock................................ -- -- (35,000) Net proceeds from the sale of common stock................ -- -- 64,856 Proceeds from the exercise of stock options............... -- -- 33 Repayment of note payable to related party................ (9) (8) (8) Payment on notes receivable from shareholders for purchase of common stock......................................... -- -- 230 Cash dividends paid on Series B Redeemable Preferred Stock................................................... -- -- (590) ------- -------- -------- Net cash (used in) provided by financing activities........................................ (270) (8) 43,567 Effect of exchange rate changes on cash and cash equivalents............................................... -- -- (185) ------- -------- -------- Net increase in cash and cash equivalents................... $ 2,096 $ 6,885 $ 30,662 Cash and cash equivalents, beginning of period.............. -- 2,096 8,981 ------- -------- -------- Cash and cash equivalents, end of period.................... $ 2,096 $ 8,981 $ 39,643 ======= ======== ======== Supplemental disclosures of consolidated cash flow information: Cash paid during the year for: Interest................................................ $ 8 $ 5 $ 240 ======= ======== ======== Income taxes............................................ $ 938 $ 2,054 $ 1,874 ======= ======== ======== Supplemental schedule of noncash investing and financing activities: Note receivable from shareholders for purchase of common stock................................................... $ 2,200 $ 750 ======= ======== Conversion of Series A Redeemable Preferred Stock to Common Stock............................................ $ 15,000 ======== Tax benefit related to stock option exercises............. $ 168 ======== Unrealized loss on available-for-sale securities.......... $ 26 ========
See Note 2 for details of assets acquired and liabilities assumed in purchase transactions. See accompanying notes to consolidated financial statements. F-6 70 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Nature of Operations -- Quest Software, Inc., a California corporation, (the Parent) and its subsidiaries (collectively the Company) provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications, and enable the delivery of information across the entire enterprise. The Company also provides consulting, training, and support services to its customers. The accompanying consolidated financial statements include the accounts of the Parent and its wholly owned subsidiaries in Australia, the United Kingdom, Germany, Israel, and Ireland. All significant intercompany transactions and balances have been eliminated in consolidation. Stock Split -- On June 23, 1998, the Company's Board of Directors approved and effected a 1,300-for-1 stock split of the Company's common stock, and on March 10, 1999, the Company's Board of Directors approved and effected a 2-for-1 stock split. On June 4, 1999, in connection with the public offering of the Company's common stock, the Company's Board of Directors approved and effected a 3-for-2 stock split of the Company's common stock. All share, per share and conversion amounts relating to common stock, preferred stock, and stock options included in the accompanying consolidated financial statements and footnotes have been restated to reflect the stock splits and for all periods presented. Foreign Currency Translation -- In accordance with Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation, the United States dollar is considered to be the functional currency for the Company's foreign subsidiaries, as such subsidiaries act as sales offices for the Parent. Therefore, gains or losses from translation adjustments are included in other income in the Company's consolidated statements of operations. Translation adjustments were not material for the years ended December 31, 1997, 1998 and 1999. However, due to the increase in international operations, the Company's results of operations could be impacted in the future. Fair Value of Financial Instruments -- The Company's consolidated balance sheets include the following financial instruments: cash, accounts receivable, notes receivable, accounts payable, and accrued liabilities. The Company considers the carrying value of cash, accounts receivable, accounts payable, and accrued liabilities in the consolidated financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. Based on borrowing rates currently available, the fair value of the notes receivable from the sale of common stock at December 31, 1999, was approximately $3,669. Cash and Cash Equivalents -- Cash equivalents include short-term, highly liquid investments with original maturities of three months or less. Interest income, included in other income (expense) in the accompanying consolidated statements of operations, was, $72, $372, and $1,514 for the years ended December 31, 1997, 1998 and 1999, respectively. Accounts Receivable -- The Company sells and/or licenses its products and services to various companies across several industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and sales returns. Investments -- The Company has classified all debt securities with original maturities of greater than three months as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity net of applicable income taxes. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in other income. The cost basis for realized gains and losses on available-for-sale securities is determined on a specific identification basis. The Company has classified available-for-sale securities as current or long-term based primarily on the maturity date of the related securities. F-7 71 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 1999, the Company had available-for-sale debt securities with a fair market value of $15,484 and a cost basis of $15,510. The unrealized loss of $26 has been recorded as a separate component of stockholders' equity, and consisted of five positions, all with unrealized losses. Property and Equipment -- Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the improvements or the term of the related lease. Repair and maintenance costs are expensed as incurred. Long-Lived Assets -- The Company accounts for the impairment and disposition of long-lived assets in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets to determine whether or not an impairment to such value has occurred. At December 31, 1998 and 1999, there was no impairment of long-lived assets. Purchased Technology and Software Licenses -- Purchased technology is recorded either at cost or, for amounts related to acquisitions, at appraised value and amortized using the straight-line method over estimated useful lives of three years to five years. Accumulated amortization was $1,483, $1,638 and $1,777 at December 31, 1997, 1998, and 1999, respectively. Software licenses are recorded at cost and are amortized over the shorter of the estimated useful lives of the related products or the term of the license. Accumulated amortization was $644, $871 and $1,027 at December 31, 1997, 1998 and 1999, respectively. The net carrying amount of purchased technology and software licenses was considered recoverable at December 31, 1998 and 1999, based on the undiscounted future cash flows expected to be realized from continued sales of the related software products. Other Assets -- Other assets include amounts receivable related to a settlement agreement the Company entered into with a former employee. Under the terms of the settlement agreement, the Company received a lump-sum payment totaling $220 in January 1997, and a promissory note providing for 40 monthly payments of $4 each commencing March 1, 1997. Approximately $63 and $25 of the settlement receivable is recorded in other current assets in the accompanying consolidated financial statements at December 31, 1998 and 1999, respectively. Goodwill -- Goodwill arising from acquisitions (Note 2) is amortized on a straight-line basis over five years. The Company will annually evaluate the carrying value of goodwill for impairment of value based on undiscounted future cash flows. Capital Distribution in Excess of Basis in Common Stock -- In connection with the repurchase of common stock in April 1999 from a major stockholder (Note 4) the excess of the repurchase price over the original cost of the shares has been recorded as a capital distribution in excess of the basis of the common stock in the accompanying consolidated financial statements. Revenue Recognition -- During October 1997, the Financial Accounting Standards Board (FASB) issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which provides guidance in recognizing revenue on software transactions. SOP 97-2 is effective for transactions entered into in fiscal years beginning after December 15, 1997, and supersedes SOP 91-1. The Company adopted this statement, as amended, for the year ended December 31, 1998, and such adoption did not have any impact on the Company's results of operations. Software Licenses, Services, and Post-Contract Customer Support -- Revenues from sales of software licenses, which generally do not contain multiple elements, are recognized upon shipment of the related product if the requirements of SOP 97-2, as amended, are met. If the requirements of SOP 97-2, F-8 72 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS including evidence of an arrangement, customer acceptance, a fixed or determinable fee, collectibility or vendor-specific objective evidence about the value of an element are not met at the date of shipment, revenue recognition is deferred until such items are known or resolved. Amounts recorded at December 31, 1998 and 1999 for deferred license revenue represent sales in which the Company has received some payments, but all of the requirements of SOP 97-2 have not been met. Revenue from service and post-contract customer support is deferred and recognized ratably over the term of the contract. Software Development Costs -- Costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs are capitalized in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. Because the Company believes that its current process for developing software is essentially completed concurrently with the establishment of technical feasibility, no software development costs have been capitalized as of December 31, 1998 and 1999. Advertising Expenses -- Advertising expenses were $300, $594 and $998 for the years ended December 31, 1997, 1998 and 1999, respectively. Income Taxes -- The Company accounts for its income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Deferred taxes on income result from temporary differences between the reporting of income for financial statements and tax reporting purposes. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Stock-Based Compensation -- The Company accounts for stock-based awards to employees, using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Net Income Per Share -- The Company computes net income per share in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other common stock equivalents, including stock options, in the weighted average number of common shares outstanding for a period, if dilutive. For the year ended December 31, 1999, net income applicable to common shareholders was $2,807 representing net income for the year of $3,397 less Preferred Stock dividends of $590 associated with the Series B Redeemable Preferred Stock (Note 7). The table below sets forth the reconciliation of the denominator of the earnings per share calculation:
YEAR ENDED DECEMBER 31, --------------------------- 1997 1998 1999 ------- ------- ------- Shares used in computing basic net income per share..... 40,373 44,261 37,677 Conversion of Series A Preferred Stock.................. -- -- 1,238 Dilutive effect of stock options........................ 244 198 2,885 ------- ------- ------- Shares used in computing diluted net income per share... 40,617 44,459 41,800 ======= ======= =======
The conversion of the Series A Preferred Stock into common stock reflects the weighted average of such shares per SFAS No. 128. F-9 73 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Comprehensive Income -- For the year ended December 31, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. There was no difference between the net income and the comprehensive net income for the years ended December 31, 1997 and 1998. For the year ended December 31, 1999, the difference between net income and comprehensive net income was an unrealized loss for available-for-sale securities of $26. Use of Estimates -- The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Risks and Uncertainties -- The Company is subject to risks and uncertainties in the normal course of business, including customer acceptance of its products, rapid technological changes, delays in introducing and market acceptance of new products, competition, e-business developments, the impact of the Year 2000, international expansion, ability to attract and retain qualified personnel, ability to protect its intellectual property, and other matters inherent in the software industry. NEW ACCOUNTING PRONOUNCEMENTS: The Company has adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. In accordance with SFAS No. 131, the Company has disclosed in Note 10 certain information about operating segments and certain information about the Company's revenue types, geographic areas to which the Company sells its products, and major customers. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which the Company is required to adopt effective in its fiscal year 2001. SFAS No. 133 will require the Company to record all derivatives on the balance sheet at fair value. The Company does not currently engage in hedging activities but will continue to evaluate the effects of adopting SFAS No. 133. 2. ACQUISITIONS On April 12, 1996, through a majority-owned subsidiary in the United Kingdom, the Company acquired certain net assets of System Software International Limited (SSI). The acquisition was accounted for under the purchase method of accounting, and the purchase price of approximately $119 was allocated to net assets of $30 and goodwill of $89. At December 31, 1996, expected future undiscounted cash flows from SSI did not support the recoverability of the goodwill resulting in the write-off of the remaining unamortized balance. In March 1997, the Company elected to discontinue funding the subsidiary, and in July 1997 commenced liquidation proceedings. During the year ended December 31, 1999, the liquidation was completed without a material loss to the Company. On May 1, 1997, the Company entered into an agreement to acquire the net assets of Common Sense Computing Pty. Ltd. (CSC) for 663 shares of the Company's common stock. At the closing date, 597 shares valued at $413 were issued to the seller, with the remaining 66 shares to be issued in June 1998, provided that the seller performed certain obligations under the indemnification provisions in the agreement. The acquisition was accounted for under the purchase method of accounting and the purchase price was allocated $320 to technology rights based upon the estimated fair value at the date of acquisition, $53 to property, plant and equipment, $100 to cash, and $60 to liabilities assumed. CSC's operating results have been included in the Company's financial statements from the date of acquisition. On June 15, 1998, the remaining 66 shares of common stock were issued resulting in an allocation of an additional $66 to technology rights, based on the fair market value of the Company's common stock at the time of issuance. F-10 74 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On July 1, 1999, the Company, through its wholly owned subsidiaries in Israel and Ireland, acquired certain assets of Neptune Software Ltd. for a cash payment of $484. The acquisition was accounted for under the purchase method of accounting and the purchase price was allocated to net assets of $474 and goodwill of $10. On December 17, 1999, the Company, through a majority owned subsidiary, acquired all of the outstanding common stock and stock options of MBR Technologies, Inc. (MBR) in exchange for 93 shares of the Company's common stock valued at $9,324, a cash payment of $1,314, and the assumption of net liabilities of $340, including a note payable to Quest of $507. The acquisition was accounted for as a purchase and the purchase price of $10,750, which included $112 of direct acquisition costs, was allocated as follows: Current assets.............................................. $ 308 Deferred taxes.............................................. 339 Fixed assets................................................ 123 Goodwill.................................................... 11,534 Liabilities assumed......................................... (1,110) Acquisition liabilities..................................... (444) ------- Total purchase price................................... $10,750 =======
The acquisition liabilities consist of $36 related to the buyout of an operating lease and $408 related to the cost of an abandoned lease on MBR's facility reduced by the monthly lease costs up to the date of abandonment. MBR's operating results have been included in the Company's financial statements from the date of acquisition. Goodwill will be amortized on a straight-line basis over five years. The following unaudited pro forma condensed consolidated results of operations assumes that the MBR acquisition had occurred on the first day of the Company's fiscal year ended December 31, 1998. The pro forma condensed consolidated results of operations, presented for information purposes only, is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of the combined enterprise.
YEARS ENDED DECEMBER 31, ------------------- 1998 1999 ------- ------- Net revenues................................................ $35,058 $71,438 Net loss.................................................... $ (512) $ (72) Net loss per share: Basic and diluted......................................... $ (0.01) $ (0.00)
In connection with the employment agreements of certain of the MBR shareholders by Quest, bonus payments of up to $6,000 could be earned over a two-year period ending in 2002 if certain sales of MBR products, based on a formula, exceed $4,000 and $8,000. Such bonus payments, if any, will be recorded as compensation expense when and if such bonuses are earned. On January 7, 2000, the Company, through a majority owned subsidiary, acquired all of the outstanding common stock of Foglight Software, Inc. in exchange for 1,188 shares of the Company's common stock valued at $104,168, cash payments estimated to be $437, the assumption of unvested Foglight stock options valued at $2,200 and the assumption of net liabilities estimated to be $4.1 million. The acquisition will be accounted for as a purchase and the purchase price, including $193 of direct acquisition costs will be allocated primarily to goodwill and intangible assets which will be amortized over two to five years. Quest also had notes receivable from Foglight of $1,308 at December 31, 1999. F-11 75 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On February 1, 2000, the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock of QMaster Software Solutions (QMaster) for a cash payment of $15,000 including an estimated $75 in direct acquisition costs. The acquisition was accounted for as a purchase and the purchase price is expected to be allocated primarily to goodwill and other intangible assets. 3. PROPERTY AND EQUIPMENT Net property and equipment consist of the following at December 31:
1998 1999 ------- ------- Furniture and fixtures...................................... $ 596 $ 2,262 Machinery and equipment..................................... 270 758 Computer equipment.......................................... 1,711 5,311 Computer software........................................... 315 692 Leasehold improvements...................................... 109 407 ------- ------- 3,001 9,430 Less accumulated depreciation and amortization.............. (1,613) (2,251) ------- ------- Property and equipment, net................................. $ 1,388 $ 7,179 ======= =======
4. RELATED-PARTY TRANSACTIONS In 1994, the Company borrowed $32 from a shareholder for the purchase of certain fixed assets. The note payable bears interest at 8.5% per annum, payable monthly, and requires monthly principal and interest payments of $1 through December 31, 1999. Approximately $8 was included in other accrued expenses in the accompanying consolidated financial statements representing the remaining outstanding note payable balance at December 31, 1998. The remaining note payable balance was repaid during 1999. During 1997, the Company received a note receivable from an officer of the Company for the purchase of 3,900 shares of the Company's common stock at $0.56 per share. The note receivable plus accrued interest is due April 2002 and bears interest at 6.2%. The note receivable and accrued interest is secured by the common stock. During 1998, the Company received a note receivable from another officer of the Company for the purchase of 975 shares of the Company's common stock at $0.77 per share. The note receivable plus accrued interest is due April 2003 and bears interest at 5.7%. Up to 25% of the unpaid principal and accrued interest may be repaid in each year during the four-year term of the note. The Company has the option to repurchase any shares at the original issuance price associated with the unpaid principal balance if the officer ceases to be employed by the Company. All of the outstanding unpaid principal and interest may be prepaid at any time when the current Chief Executive Officer of the Company ceases to be employed or immediately prior to a sale of substantially all of the assets of the Company or a merger in which the Company is not the surviving entity. The note receivable and accrued interest is secured by the common stock. In April 1999, the Company repurchased and cancelled 14,820 shares of common stock from a shareholder of the Company at a price of $2.36 per share. The Company also entered into a severance agreement with the shareholder whereby the shareholder will receive $200 per year through 2001 and provides for use of a company car and related expenses and medical benefits. The Company recorded approximately $715 of expense related to the agreement in April 1999, which is included in compensation and other costs in the accompanying consolidated financial statements. F-12 76 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. TERM NOTE In connection with the repurchase of common stock from a shareholder in April 1999 (Note 4), the Company borrowed $10,000 under a term note with a bank. The borrowings under the term note were secured by substantially all assets of the Company, bore interest, at the Company's option, at either the bank's prime rate or at the LIBOR rate plus a maximum of 2.75% per annum, required monthly interest payments commencing June 1, 1999, and the principal was payable in 24 monthly installments of $417 commencing June 1, 2000. All unpaid principal and interest was due on May 1, 2002. The loan contained covenants relating to certain financial statement amounts related to tangible net worth, cash flow from operations, and a debt to cash flow from operations and quick ratios. The Company repaid the note after its initial public offering in August, 1999. 6. INCOME TAXES The provision for income taxes consists of the following for the years ended December 31:
1997 1998 1999 ------ ------ ------- Current: Federal....................................... $1,359 $1,819 $ 2,763 State......................................... 102 425 402 Foreign....................................... -- 78 808 ------ ------ ------- 1,461 2,322 3,973 Deferred: Federal....................................... (360) (568) (1,391) State......................................... (79) (75) (309) Foreign....................................... (85) (165) (122) ------ ------ ------- (524) (808) (1,822) Change in valuation allowance................... 85 165 122 ------ ------ ------- Total income tax provision............ $1,022 $1,679 $ 2,273 ====== ====== =======
The reconciliation of income tax expense computed at U.S. federal statutory rates to income tax expense for the years ended December 31, 1997, 1998 and 1999, is as follows:
1997 1998 1999 ----- ---- ---- Tax at U.S. federal statutory rates............... 35.0% 35.0% 35.0% State taxes....................................... 2.0 5.7 1.1 Recording of deferred income tax liabilities in connection with the conversion to a C corporation..................................... 45.2 -- -- Foreign taxes..................................... 6.2 6.0 8.3 Research and development credits.................. (10.4) (4.6) (4.7) Other............................................. -- (0.4) 0.4 ----- ---- ---- 78.0% 41.7% 40.1% ===== ==== ====
F-13 77 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes as of December 31, 1998 and 1999, are as follows:
1998 1999 ----- ------- Deferred tax assets: Accounts receivable and sales returns reserves.......... $ 313 $ 871 Accrued liabilities..................................... 165 892 Foreign net operating loss carryforwards................ 250 127 U.S. net operating loss carryforwards................... -- 339 Intangible assets....................................... 264 453 Stock compensation...................................... -- 184 Other................................................... 56 -- ----- ------- Total gross deferred assets............................... 1,048 2,866 Deferred tax liabilities: Cash to accrual adjustment.............................. (301) (150) State taxes............................................. (32) (47) Fixed assets............................................ -- (38) ----- ------- Total gross deferred liabilities.......................... (333) (235) Valuation allowance....................................... (250) (127) ----- ------- Net deferred income taxes................................. $ 465 $ 2,504 ===== ======= Less current portion...................................... (198) (2,089) ----- ------- $ 267 $ 415 ===== =======
The Company has U.S. net operating loss carryforwards of $889 that are subject to limitation by Internal Revenue Code Section 382 and begin to expire in 2018. The Company has foreign net operating loss carryforwards of $425 that can be carried forward indefinitely. Effective January 1, 1997, the Company converted to a C corporation and became subject to regular federal and state income taxes on an ongoing basis. As a result, the Company recorded $617 of net deferred income tax liabilities on January 1, 1997. Total cash distributions charged against retained earnings include payments of $261 in 1997, made to the Company's shareholders. 7. SHAREHOLDERS' EQUITY In April 1999, the Company issued 2,667 shares of Series A Preferred Stock (Series A) for $15,000 and 1,778 shares of Series B Redeemable Preferred stock (Series B) for $10,000. Series A shares were convertible at the holder's option into shares of common stock, based on the conversion ratio defined in the agreement. The conversion ratio could be adjusted, from time to time, in the event of certain diluting events, as defined. Conversion was automatic in the event of a public offering of the Company's common stock, that met certain specified criteria initially at a rate of 1.5 shares of common stock for each share of preferred stock. Additionally, the holders of not less than a majority of the Series A shares had the right to redeem the Series A shares for cash in two equal installments due on April 30, 2006 and 2007, respectively. The redemption price would be determined on each date by the then applicable liquidation preference. Upon the election of not less than a majority of the Series A holders to redeem the Series A shares, all Series A shares would be redeemed. Dividends on Series A F-14 78 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS were cumulative on a "when and as if declared" basis at a rate of 8% per share per annum. Series A shareholders had the right to elect one director and have veto rights over certain management decisions. In the event of liquidation, dissolution or winding up of the Company, each Series A shareholder had a liquidation preference equal to $5.625 per share, plus an amount equal to all accrued but unpaid dividends, with respect to such shares plus an amount equal to a prorated dividend from the last dividend payment date to the date fixed for liquidation, dissolution, or winding up. In connection with the Company's initial public offering in August 1999, all outstanding shares of Series A Preferred Stock were converted into 4,000 shares of common stock. Series B shares were convertible into shares of Series A shares one year after the issuance of the Series B shares at the holder's option based on the ratio defined in the agreement. If the Series A shares were not converted into common stock, Series B shares were convertible into shares of Series A preferred stock at the Company's option prior to the one year anniversary of the date of issuance of the Series B shares. The conversion ratio could be adjusted, from time to time, in the event of certain diluting events, as defined. Dividends on Series B were cumulative and could be declared at the discretion of the Board of Directors. The dividend rate was 18% per share per annum. Series B shareholders did not have voting rights with the exception of the redemption provisions discussed below. In the event of liquidation, dissolution or winding up of the Company, each Series B shareholder had a liquidation preference equal to $5.625 per share, plus an amount equal to all accrued but unpaid dividends, with respect to such shares plus an amount equal to a prorated dividend from the last dividend payment date to the date fixed for liquidation, dissolution, or winding up. Additionally, the holders of the Series B shares and the Company had the right to redeem the Series B shares for cash at any time one year following the issuance of the Series B shares, or, if earlier, upon consummation of an initial public offering. The redemption price was determined on the redemption date by the then applicable liquidation preference. In connection with the Company's initial public offering in August 1999, the Series B shares were redeemed for $10,000 plus dividends of $590. 8. STOCK OPTION PLANS In connection with a prior acquisition, the Company entered into an employment agreement with the president of the acquired company under which options to purchase up to 2.5% of the Company's outstanding common stock at $0.77 per share were granted. The agreement provided for issuance of additional common shares to the individual in the event the Company issued common shares to employees, subject to limitations as defined in the agreement. In connection with the issuance of 975 shares of common stock to this individual in 1998 (Note 4), the option was cancelled. In May 1998, the Company adopted the 1998 Stock Option/Stock Issuance Plan (the Plan). Under the terms of the Plan, options to purchase 7,500 shares of the Company's common stock were reserved for issuance to employees, directors, and consultants. 1999 STOCK INCENTIVE PLAN The 1999 Stock Incentive Plan is intended to serve as the successor equity incentive program to the 1998 Stock Option/Stock Issuance Plan. The 1999 Stock Incentive Plan was adopted by the Board and subsequently approved by the shareholders on June 9, 1999. The 1999 Stock Incentive Plan became effective upon its adoption by the Board. On the date of the Company's initial public offering, all outstanding options under the 1998 plan were incorporated into the 1999 Stock Incentive Plan, and no further option grants will thereafter be made under the 1998 plan. The incorporated options will continue to be governed by their existing terms, unless the plan administrator elects to extend one or more features of the 1999 Incentive Plan to those options. Except as otherwise noted below, the incorporated options F-15 79 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS have substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve -- At December 31, 1999, 7,478 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan of which 2,210 shares are available for issuance. The share reserve consists of the number of shares that remain available for issuance under the 1998 plan and shares of common stock subject to outstanding options thereunder. No participant in the 1999 Stock Incentive Plan may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances for more than 500 shares of common stock in total per calendar year. Programs -- The 1999 Stock Incentive Plan is divided into five separate programs: - The discretionary option grant program under which eligible individuals may be granted options to purchase shares of common stock at an exercise price determined by the plan administrator; - The stock issuance program under which individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - The salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - The automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee Board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - The director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee Board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration -- The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the Board of Directors. Plan Features -- The 1999 Stock Incentive Plan includes the following features: - The exercise price for any options granted under the plan may be paid in cash or in shares of common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. - The compensation committee will have the authority to cancel outstanding options under the discretionary option grant program in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date. - Stock appreciation rights may be issued under the discretionary option grant program. Such rights will provide the holders with the election to surrender their outstanding options for an appreciation distribution from the Company equal to the fair market value of the vested shares of common stock subject to the surrendered option less the exercise price payable for those shares. Payment can be made in cash or in shares of common stock. F-16 80 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Change in Control -- The 1999 Stock Incentive Plan includes the following change in control provisions, which may result in the accelerated vesting of outstanding option grants and stock issuances: - In the event that the Company is acquired by merger or asset sale or a Board-approved sale of more than fifty percent of the then outstanding stock, each outstanding option under the discretionary option grant program which is not assumed or continued by the successor corporation will immediately become exercisable for all the option shares, and all unvested shares will immediately vest, except to the extent the Company's repurchase rights with respect to those shares are assigned to the successor corporation. - The plan administrator will have complete discretion to grant one or more options which will become exercisable for all the option shares in the event those options are assumed in an acquisition, but the optionee's service with the Company or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than 50% of the outstanding voting stock or a change in the majority of our board of directors through one or more contested elections. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service. Salary Investment Option Grant Program -- In the event the compensation committee decides to put this program into effect for one or more calendar years, each of the Company's executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10 nor more than $75. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. Compensation expense will be recorded for the amount of the salary reduction. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control. Automatic Option Grant Program -- Each individual who first becomes a non-employee Board member at any time after the completion of this offering will automatically receive an option grant for 25 shares on the date such individual joins the Board, provided such individual has not been in the prior employ of the Company. In addition, on the date of each annual shareholders meeting, beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee Board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 8 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of Board service. The initial 25-shares option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by us, at the exercise price paid per share, should the optionee cease Board service prior to vesting in those shares. The shares subject to each 25 share automatic option grant will vest over a four-year period in F-17 81 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS successive equal annual installments upon the individual's completion of each year of board service over the four-year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of the Company or upon the optionee's death or disability while a Board member. Each 8 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program -- If this program is put into effect, each non-employee Board member may elect to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares will be equal to the portion of the retainer fee invested in that option. The option will become exercisable in a series of twelve equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon certain changes in the ownership or control or the death or disability of the optionee while serving as a Board member. Limited Stock Appreciation Rights -- Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, salary investment option grant and director fee option grant programs and may be granted to one or more of the Company's officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to the Company upon the successful completion of a hostile tender offer for more than 50% of the Company's outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from the Company in an amount per surrendered option share based on the highest price per share of common stock paid in connection with the tender offer. Amendment -- The board may amend or modify the 1999 Stock Incentive Plan at any time, subject to any required shareholder approval. The 1999 Stock Incentive Plan will terminate no later than June 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction -- The 1999 Employee Stock Purchase Plan was adopted by the Board and approved by the shareholders in June 1999 and will become effective immediately upon the effective date of the Company's initial public offering. The 1999 Employee Stock Purchase Plan is designed to allow eligible employees and the employees of participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions. Share Reserve -- At December 31, 1999, 600 shares of common stock were reserved for issuance. In February, 2000, 119 shares of common stock were purchased under the plan. At December 31, 1999, $1,269 was recorded in accrued liabilities that employees had deposited for purchases of common stock under the plan. Purchase Periods -- The plan has a series of successive purchase periods, each with a maximum duration of six months. The initial purchase period began on August 12, 1999 and ended on the last business day in January 2000. Thereafter, purchase periods run from the first business day in February to the last business day in July of each year, and from the first business day in August to the last business day in January of the following year. F-18 82 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Eligible Employees -- Individuals who are scheduled to work more than 20 hours per week for more than five calendar months per year on the start date of any purchase period may join the plan on such start date. Payroll Deductions -- A participant may contribute up to 15% of their cash earnings, and the accumulated payroll deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% the fair market value of the common stock on the start date of the purchase period or, if lower, the fair market value on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of January and July each year. In no event, however, may any participant purchase more than .6 shares on any semi-annual purchase date. Change in Control -- In the event the Company is acquired by merger or asset sale, all outstanding purchase rights will automatically be exercised immediately prior to the effective date of the acquisition. The purchase price will be equal to 85% of the fair market value per share of common stock on the participant's entry date into the offering period in which such acquisition occurs or, if lower, the fair market value per share of common stock immediately prior to such acquisition. Termination/Amendment -- The 1999 Employee Stock Purchase Plan will terminate on the last business day of July 2009. The Board may at any time alter, suspend or discontinue the plan. However, certain amendments to the plan may require shareholder approval. As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company has chosen to continue to account for its stock-based compensation plans under APB Opinion No. 25 and provide the expanded disclosures specified in SFAS No. 123. Compensation costs would not have significantly changed net income or net income per share in fiscal 1997. Had compensation cost been determined using the provisions of SFAS No. 123, the Company's net income available to common shareholders would have been decreased to the pro forma amounts indicated below:
DECEMBER 31, DECEMBER 31, 1998 1999 ------------ ------------ Net income available to common shareholders: As reported............................................... $2,346 $2,807 ====== ====== Pro forma................................................. $2,177 $ 202 ====== ====== Basic net income per share: As reported............................................... $ 0.05 $ 0.07 ====== ====== Pro forma................................................. $ 0.05 $ 0.01 ====== ====== Diluted net income per share: As reported............................................... $ 0.05 $ 0.07 ====== ====== Pro forma................................................. $ 0.05 $ 0.00 ====== ======
For purposes of estimating the compensation cost of the Company's option grants in accordance with SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted average assumptions used for grants in the years 1997 and 1998, as a private company: expected volatility of zero; risk-free interest rates of 6%; and expected lives of ten years. Weighted average assumptions for 1999 were: expected volatility of 221%; risk-free interest rates of 6%; and expected lives of five years. F-19 83 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes activity under all of the Company's stock option plans:
DECEMBER 31, --------------------------------------------------------- 1997 1998 1999 ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------ -------- ------ -------- ------ -------- Outstanding, beginning of period........ 1,531 $0.64 975 $0.77 3,367 $ 1.19 Granted................................. -- $ -- 3,383 $1.19 2,391 $14.05 Exercised............................... -- $ -- -- $ -- (34) $ 1.00 Canceled................................ (556) $0.40 (991) $0.77 (468) $ 3.20 ----- ----- ----- ------ Balance, end of period.................. 975 $0.77 3,367 $1.19 5,256 $ 6.87 Weighted average fair value of options granted during the year............... -- $0.53 $13.42 ===== ===== ======
The Company will record compensation expense of approximately $2,978 relating to options granted during the year ended December 31, 1999, to purchase 530 shares of common stock. The expense equals the difference between the fair market value of the Company's common stock on the grant date and the exercise price of the stock options and will be recognized ratably over the four-year vesting period of the stock options. The Company recorded $432 of expense associated with such option grants during the year ended December 31, 1999 which is included in compensation and other costs in the accompanying consolidated financial statements.
DECEMBER 31, 1999 ------------------------------------------------------------- OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE --------------- ----------- ----------- -------- ----------- -------- $ 1.00 -- 1.00......................... 2,161 8.49 $ 1.00 578 $1.00 $ 1.17 -- 3.77......................... 2,166 9.00 $ 2.33 125 $1.17 $ 6.00 -- 12.00......................... 473 9.53 $10.38 -- -- $37.00 -- 45.00......................... 192 9.74 $41.03 -- -- $50.75 -- 64.13......................... 198 9.90 $54.34 -- -- $80.50 -- 80.50......................... 66 9.92 $80.50 -- -- ----- --- 5,256 703 $1.03 ===== === =====
Options to purchase 47 shares of common stock at exercise prices of $1.00 to $1.17 per share were exercised in January 2000. 9. COMMITMENTS AND CONTINGENCIES The Company leases its office facilities and certain equipment under various operating leases. The majority of these leases are non-cancelable and obligate the Company to pay costs of maintenance, utilities, and applicable taxes. The leases on most of the office facilities contain escalation clauses and renewal options. Total rent expense was $732, $1,038 and $2,593, for the years ended December 31, 1997, 1998, and 1999. F-20 84 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Minimum lease commitments under noncancelable operating leases at December 31, 1999, are as follows: Year ending December 31: 2000............................................. $ 3,457 2001............................................. 3,353 2002............................................. 3,245 2003............................................. 2,739 2004............................................. 2,656 Thereafter....................................... 4,652 ------- $20,102 =======
As a result of the acquisition of MBR (Note 2), the Company is obligated under capital lease agreements for certain property and equipment requiring monthly installments of principal and interest (at 10%) through 2004. The present value of the remaining capital lease payments is $114 at December 31, 1999. The Company maintains a profit-sharing plan covering substantially all employees. Quarterly contributions may be made by the Company based upon employee salaries. Effective January 1, 1997, the Company amended and restated the profit sharing plan to include a 401(k) plan. The Company contributed $134, $466 and $929 to the amended plan for the years ended December 31, 1997, 1998 and 1999, respectively. On May 25, 1999, Mobius Management Systems, Inc., filed a complaint in the United States District Court for the District of New Jersey (Mobius Management Systems, Inc. v. Quest Software, Inc., Case No. 99-2337). The complaint alleged that the Company published three advertisements that were false and misleading and, therefore, in violation of the Lanham Act and common law, and that the Company misappropriated unspecified trade secrets belonging to Mobius. The advertisements that Mobius alleged in its complaint are false and misleading were two e-mails intended for internal use, a comparison chart believed to have been prepared by a former Company employee in 1997 for internal purposes, and a statement made regarding the Company's Vista Plus Java client which had been posted on the Internet. The case was settled in late 1999, with both sides agreeing to pay their own legal fees. No other expenses were incurred by the Company in connection with this matter. The Company is involved in various claims and legal actions arising in the ordinary course of business. The litigation process is inherently uncertain, and it is possible that the resolution of such claims and legal actions may adversely affect the Company. However, it is the opinion of management that the ultimate disposition of these matters will not materially affect the Company's results of operations or financial position. 10. GEOGRAPHIC INFORMATION AND CONCENTRATION OF CREDIT RISK Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company's chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The operating segments of the Company are managed separately because each segment represents a strategic business unit that offers different products or services. The Company's reportable operating segments include Licenses and Services. The Software Licenses operating segment develops and markets the Company's software products. The Services segment provides after-sale support for software products and fee-based training and consulting services related to the Company's products. F-21 85 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company does not separately allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of sales and gross profit, as this information and the geographic information described below are the only information provided to the chief operating decision-maker. Operating segment data for the three years in the period ended December 31, 1999, was as follows:
LICENSES SERVICES TOTAL -------- -------- ------- Year ended December 31, 1997: Revenues.................................................. $12,158 $ 6,157 $18,315 Cost of revenues.......................................... 1,307 1,972 3,279 ------- ------- ------- Gross profit........................................... $10,851 $ 4,185 $15,036 ======= ======= ======= Year ended December 31, 1998: Revenues.................................................. $24,901 $ 9,889 $34,790 Cost of revenues.......................................... 3,433 2,507 5,940 ------- ------- ------- Gross profit........................................... $21,468 $ 7,382 $28,850 ======= ======= ======= Year ended December 31, 1999: Revenues.................................................. $54,269 $16,599 $70,868 Cost of revenues.......................................... 2,998 4,195 7,193 ------- ------- ------- Gross profit........................................... $51,271 $12,404 $63,675 ======= ======= =======
Revenues are attributed to geographic areas based on the location of the entity to which the products or services were sold. Revenues, gross profit, income (loss) from operations and long-lived assets concerning principal geographic areas in which the Company operates are as follows:
UNITED STATES INTERNATIONAL ELIMINATIONS TOTAL ------- ------------- ------------ ------- Year ended December 31, 1997: Revenues..................................... $17,511 $ 1,261 $ (457) $18,315 Gross profit................................. 14,413 1,075 (452) 15,036 Income (loss) from operations................ 1,533 (339) 254 1,448 Long-lived assets............................ 2,336 118 -- 2,454 Year ended December 31, 1998: Revenues..................................... $32,189 $ 4,172 $(1,571) $34,790 Gross profit................................. 26,594 3,840 (1,584) 28,850 Income (loss) from operations................ 3,839 (252) 102 3,689 Long-lived assets............................ 1,600 315 -- 1,915 Year ended December 31, 1999: Revenues..................................... $55,532 $19,736 $(4,400) $70,868 Gross profit................................. 55,389 8,701 (415) 63,675 Income from operations....................... 3,270 693 505 4,468 Long-lived assets............................ 17,839 1,233 -- 19,072
In fiscal 1997, 1998 and 1999, no single customer accounted for 10% or more of total revenue. No single international location accounted for more than 5% of total revenues for any of the periods indicated. F-22 86 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH FISCAL QUARTER QUARTER QUARTER QUARTER YEAR -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31, 1999 Revenue.................................... $12,839 $15,450 $18,308 $24,271 $70,868 Gross profit............................... 11,251 13,896 16,420 22,108 63,675 Income before income taxes................. 1,632 641 902 2,495 5,670 Net income applicable to common shareholders............................ 943 31 272 1,561 2,807 Basic earnings per share................... 0.02 0.00 0.01 0.04 0.07 Diluted earnings per share................. 0.02 0.00 0.01 0.04 0.07 YEAR ENDED DECEMBER 31, 1998 Revenue.................................... $ 7,043 $ 6,992 $ 8,734 $12,021 $34,790 Gross profit............................... 5,965 5,522 7,044 10,319 28,850 Income before income taxes................. 1,483 53 1,073 1,416 4,025 Net income applicable to common shareholders............................ 868 31 627 820 2,346 Basic earnings per share................... 0.02 0.00 0.01 0.02 0.05 Diluted earnings per share................. 0.02 0.00 0.01 0.02 0.05
12. SUBSEQUENT EVENTS On January 31 and February 11, 2000, the Company entered into two non-binding letters of intent to acquire two companies for an aggregate purchase price of $25 million. F-23 87 REPORT OF INDEPENDENT AUDITORS To the Shareholders and Directors of MBR Technologies, Inc. We have audited the accompanying balance sheet of MBR Technologies, Inc., a California Corporation, as of March 31, 1999, the related statements of operations, shareholders' equity and cash flows from inception (April 23, 1998) through March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MBR Technologies Inc. as of March 31, 1999, and the results of its operations and cash flows from inception (April 23, 1998) through March 31, 1999, in conformity with generally accepted accounting principles. /s/ SWENSON ADVISORS, LLP Temecula, California September 29, 1999 F-24 88 MBR TECHNOLOGIES, INC. BALANCE SHEETS
MARCH 31, DECEMBER 17, 1999 1999 ---------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 63,055 $ 229,011 Accounts receivable....................................... 94,918 94,785 Deposits and prepaid assets............................... 21,831 23,737 ---------- ----------- Total current assets................................. 179,804 347,533 ---------- ----------- Property, equipment and software: Software.................................................. 262,722 13,548 Furniture and fixtures.................................... 55,722 79,235 Computers and equipment................................... 114,868 186,287 Leasehold improvements.................................... 9,772 9,772 ---------- ----------- 443,084 288,842 Less: accumulated depreciation.............................. (17,118) (63,131) ---------- ----------- Net property and equipment................................ 425,966 225,711 ---------- ----------- Other assets.............................................. 4,044 3,458 ---------- ----------- Total assets......................................... $ 609,814 $ 576,702 ========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities.................. $ 45,553 30,204 Other current liabilities................................. 13,001 -- Notes payable to Quest Software........................... -- 506,454 Current portion of notes payable to related parties....... 299,136 411,020 Current portion of capital lease obligations.............. 30,342 42,585 Deferred revenue.......................................... 22,912 48,540 ---------- ----------- Total current liabilities............................ 410,944 1,038,803 ---------- ----------- Long term liabilities: Capital lease obligations, net of current portion......... 52,443 70,872 ---------- ----------- Total liabilities.................................... 463,387 1,109,675 ---------- ----------- Shareholders' equity (deficit): Common stock, no par value; authorized 10,000,000 shares; Issued and outstanding 1,020,000 shares................ 1,020,000 1,020,000 Accumulated deficit....................................... (873,573) (1,552,973) ---------- ----------- Total shareholders' equity (deficit)................. 146,427 (532,973) ---------- ----------- Total liabilities and shareholders' equity........... $ 609,814 $ 576,702 ========== ===========
See Accompanying Notes to Financial Statements. F-25 89 MBR TECHNOLOGIES, INC. STATEMENTS OF OPERATIONS
FROM INCEPTION PERIOD FROM (APRIL 23, 1998) JANUARY 1, 1999 THROUGH TO MARCH 31, 1999 DECEMBER 17, 1999 ---------------- ----------------- (UNAUDITED) Revenue..................................................... $ 267,825 $ 569,958 Operating expenses: Salary expenses and related employee benefits............. 248,859 497,291 Research and development.................................. 300,873 208,660 Amortization of software costs............................ 337,278 346,452 Selling, general and administrative....................... 137,087 226,833 Professional fees and outside services.................... 92,710 87,657 Amortization and depreciation............................. 17,568 56,134 ---------- --------- Total operating expenses............................. 1,134,375 1,423,027 ---------- --------- Operating loss.............................................. (866,550) (853,069) Interest income............................................. 278 467 ---------- --------- Loss before interest and taxes.............................. (866,272) (852,602) Interest expense............................................ 6,501 31,007 Income tax provision........................................ 800 1,395 ---------- --------- Net loss.................................................... $ (873,573) $(885,004) ========== =========
See Accompanying Notes to Financial Statements. F-26 90 MBR TECHNOLOGIES, INC. STATEMENT OF SHAREHOLDERS' EQUITY FROM INCEPTION (APRIL 23, 1998) THROUGH MARCH 31, 1999 AND THE PERIOD FROM JANUARY 1, 1999 TO DECEMBER 17, 1999 (UNAUDITED)
COMMON RETAINED STOCK DEFICIT ---------- ---------- BALANCE, April 23, 1998..................................... $ -- $ -- Net loss.................................................... -- (873,573) Sale of common stock........................................ 1,020,000 -- ---------- ---------- BALANCE, March 31, 1999..................................... 1,020,000 (873,573) Unaudited: Net loss.................................................... -- (679,400) ---------- ---------- BALANCE, December 17, 1999.................................. $1,020,000 $1,552,973 ========== ==========
See Accompanying Notes to Financial Statements. F-27 91 MBR TECHNOLOGIES, INC. STATEMENTS OF CASH FLOWS
FROM INCEPTION PERIOD FROM (APRIL 23, 1998) JANUARY 1, 1999 THROUGH TO MARCH 31, 1999 DECEMBER 17, 1999 ---------------- ----------------- (UNAUDITED) Cash flows from operating activities: Net loss.................................................. $(873,573) $(885,004) Adjustments used in operating activities: Depreciation and amortization.......................... 17,568 56,234 Amortization of software costs......................... 337,278 346,452 Related party equity exchanges......................... 237,040 -- Change in notes payable to related parties............. 4,136 21,420 Changes in assets and liabilities: Increase in accounts receivable...................... (94,918) 74,660 Increase in deposits and prepaid expenses............ (21,831) 2,374 Increase in organization costs....................... (4,494) -- Increase in accounts payable and accrued liabilities....................................... 45,553 (11,127) Increase in other current liabilities................ 13,001 7,071 Increase in deferred revenue......................... 22,912 (48,540) --------- --------- Net cash used in operating activities............. (317,328) (436,460) Cash flows from investing activities: Purchase of property and equipment........................ (82,472) (51,732) --------- --------- Net cash used in investing activities............. (82,472) (51,732) Cash flows from financing activities: Proceeds from common stock................................ 173,501 22,717 Borrowings from related parties........................... 295,000 155,000 Borrowings from Quest Software............................ -- 500,000 Payments on capital lease obligations..................... (5,646) (29,933) --------- --------- Net cash provided by financing activities......... 462,855 647,784 --------- --------- Increase in cash............................................ 63,055 159,592 Cash, beginning of period................................... -- 69,419 --------- --------- Cash, end of period......................................... $ 63,055 $ 229,011 ========= ========= Supplemental Disclosure of Cash flow Information: Cash paid for interest.................................... $ 2,364 $ 31,007 ========= =========
See Notes 4 and 6 for supplemental cash flow disclosures. See Accompanying Notes to Financial Statements. F-28 92 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 -- ORGANIZATION MBR Technologies, Inc. (the "Company") was incorporated in California on April 23, 1998. The Company develops, publishes, markets, and distributes middleware solutions for enterprise software platforms. The Company's products are designed to reduce the cost of ownership and maintenance of the PeopleSoft and CSS/Horizon (ADP) environments. In addition to product sales the Company also provides annual maintenance for their software and related consulting services. The Company markets its software through several channels, including: direct sales, software showcase conferences, joint marketing relationships and value added resellers (VARs). Unaudited Information -- The accompanying statement of operations and cash flows for the period January 1, 1999 to December 17, 1999, have been prepared by the Company without audit in accordance with Generally Accepted Accounting Principles for interim financial information and, in the opinion of management, contain all adjustments consisting only of normal recurring accruals necessary for a fair presentation of such information. Such information has been prepared for use in the proforma financial statements required by Quest Software, Inc. (Quest) in connection with its acquisition in December, 1999 by Quest. NOTE 2 -- LIQUIDITY AND BUSINESS RISK The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company has an accumulated deficit of $873,573 and negative working capital of $231,140 as of March 31, 1999. The Company's ability to continue business in its present form is subject to a variety of factors, which include, among other things, the Company's ability to raise working capital and to generate profitable operations. In the opinion of management, the Company will be able to improve its profitability and raise adequate capital to meet its current working capital requirements. The Company is subject to a number of risks associated with companies at a similar stage of development including; the need for funding its operations and growth, marketplace acceptance, competition, technological obsolescence, and the retention and reliance on key personnel. On December 17, 1999, the Company was sold to Quest Software, Inc. for $10,638 which consisted of 93,471 shares of Quest's common stock valued at $9,323,732 and cash of $1,313,853. NOTE 3 -- SIGNIFICANT ACCOUNTING POLICIES Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents -- The Company considers all unrestricted highly liquid investments purchased with maturity of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value. Revenue Recognition -- Revenue from training and consulting fees is recognized when earned. Revenues from product sales and support fees are recognized in accordance with the provisions outlined in the AICPA SOP 97-2. Deferred revenue represents certain post contract customer support recognized on a monthly basis. Property and Equipment -- Property and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation is determined using the straight line method for all assets based on F-29 93 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS estimated useful lives of the assets, which range from three to seven years for furniture and equipment, and fifteen years for leasehold improvements. Software Costs -- Software costs related to the acquisition of the Stat! software have been capitalized and amortized over the useful life of the software, estimated to be twenty months. For the year ended March 31, 1999, $337,278 of these costs have been amortized. For the period January 1, 1999 to December 17, 1999, $346,452 of these costs have been amortized. Income Taxes -- For the year ended March 31, 1999 and the period from January 1, 1999 to December 17, 1999, there was no federal tax liability for financial statement or tax bases. The minimum franchise tax of $800 has been accrued. NOTE 4 -- RELATED PARTIES During the year ended March 31, 1999, the Secretary and Chief Financial Officer of the Company loaned $195,000 and $100,000, respectively, to the Company to be used for operating and investing activities. The loans are due and payable no later than September 30, 1999, and interest accrues at a rate of 5% per annum. The Company has obtained a waiver until December 31, 1999. For the year ended March 31, 1999, $4,136 of interest was accrued on these notes. During the year ended March 31, 1999, certain related parties received stock in exchange for goods and services. The Chief Executive Officer and Chief Operations Officer of the Company received 350,000 and 300,000 shares, respectively, in exchange for rights to software and related consulting for the product. The Chief Financial Officer received approximately 118,100 shares for consulting and certain equipment. NOTE 5 -- COMMON STOCK AND CAPITAL FUNDING The Company has one class of common stock. There are no preferences related to dividends, voting rights or dissolution. During the year ended March 31, 1999, $173,501 new cash was received for common stock sold to related and unrelated parties. (See Note 4) NOTE 6 -- COMMITMENTS AND CONTINGENCIES Operating Leases -- The Company leases office space under an operating lease agreement with monthly rent of $8,192; which increases to a maximum of $9,558 in 2003. Rent expense under this lease totaled $24,685 for the year ended March 31, 1999 and $81,511 for the period from January 1, 1999 to December 17, 1999. The Company also entered into an operating equipment lease at March 31 that expires in December 2001. Future minimum lease payments under these operating leases are as follows: 2000...................................................... $104,294 2001...................................................... 108,390 2002...................................................... 112,487 2003...................................................... 116,583 -------- $441,754 ========
Capital Leases -- The Company has entered into certain capital leases. Interest accrues on each of these leases at a rate of 10% annually. Lease terms range from 36 to 48 months. F-30 94 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS Future lease payments under capital leases are as follows: 2000...................................................... $ 41,160 2001...................................................... 41,160 2002...................................................... 38,476 2003...................................................... 8,293 -------- $129,089 ========
NOTE 7 -- 401(K)PLAN The Company provides a tax qualified section 401(k) plan for the benefit of eligible employees. In accordance with Plan guidelines, contributions by the employer are discretionary. During the year ended March 31, 1999, the Company contributed $8,546 to the Plan. No contributions were payable at the end of the fiscal year. The Company paid $1,700 in administrative costs for the Plan. Contributions made by the Company vest based on the employee's years of service. Vesting begins after two years of service in 20% annual increments until the employee is 100% vested after six years. NOTE 8 -- STOCK OPTION PLAN In June 1999, the Company adopted the Fiscal Year 2000 Equity Incentive Plan (2000 Plan.) Under the 1999 Plan, a maximum of 200,000 shares of Common Stock have been reserved for issuance of options. Options under the 1999 Plan may be granted at exercise prices determined by the Board of Directors, provided that the exercise prices shall not be less than 85% of the fair market of the common stock. The options vest over three years at 33.3% a year commencing on the grant date. The term of the options are not to exceed 10 years. There were no options granted under this Plan as of March 31, 1999. Approximately 11,500 options were granted after March 31, 1999 through September 29, 1999. NOTE 9 -- YEAR 2000 ISSUE (UNAUDITED) Like other organizations and individuals around the world, the Company could be adversely affected if the computer systems it uses and those used by the Company's major customers and vendors do not properly process and calculate date-related information and data from and after January 1, 2000. This is commonly known as the "Year 2000 Issue." Management is assessing its computer systems and the systems compliance issues of its major service providers. Based on information available to management, the Company's major customers and vendors are taking steps that they believe are reasonably designed to address the Year 2000 Issue with respect to computer systems that they use. At this time, however, there can be no assurance that these steps will be sufficient, and the failure of a timely completion of all necessary procedures could have a material adverse effect on the Company's operations. Management will continue to monitor the status of, and its exposure to, this issue. NOTE 10 -- NOTES PAYABLE TO QUEST SOFTWARE (UNAUDITED) Included in the accompanying financial statements at December 17, 1999 are notes and accrued interest at 7% payable to Quest Software of $506,454, which Quest Software assumed in the acquisition of the Company in December, 1999. F-31 95 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Foglight Software, Inc. (a company in the development stage) In our opinion, the accompanying balance sheet and the related statements of operations, of stockholders' deficit and of cash flows present fairly, in all material respects, the financial position of Foglight Software, Inc. at December 31, 1998 and the results of its operations and its cash flows for the period from November 10, 1997 (date of inception) to December 31, 1998 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred losses and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. The Company's ability to continue as a going concern is dependent, among other factors, on its ability to obtain sufficient financing to complete the development and commercialization of its products and to obtain adequate customers for its product. Management's plans with regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ PRICEWATERHOUSECOOPERS LLP September 13, 1999, except for Note 10, for which it is October 29, 1999 F-32 96 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) BALANCE SHEETS
DECEMBER 31, 1998 ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 2,164,741 Restricted cash........................................... 76,423 Accounts receivable....................................... -- Inventory................................................. -- Prepaid expenses and other current assets................. 189,632 ----------- Total current assets................................. 2,430,796 Property and equipment, net................................. 1,016,124 Other assets................................................ 34,344 ----------- Total assets......................................... $ 3,481,264 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable, current portion............................ $ 3,303,137 Accounts payable.......................................... 229,971 Accrued liabilities....................................... 235,214 Deferred revenue.......................................... 126,134 Capital lease obligations, current portion................ 155,980 ----------- Total current liabilities............................ 4,050,436 Notes payable, net of current portion....................... 4,063,139 Capital lease obligations, net of current portion........... 539,311 ----------- 8,652,886 ----------- Commitments (Note 6) Stockholders' equity: Series A Convertible Preferred Stock: $0.001 per value; 710,029 shares authorized; 618,680 shares issued and outstanding............................................ 612 Series B Convertible Preferred Stock: $0.001 par value; 1,700,000 shares authorized; 1,238,390 shares issued and outstanding........................................ 1,238 Series C Convertible Preferred Stock: $0.001 par value; 2,500,000 shares authorized; no shares issued and outstanding....................... -- Unearned compensation..................................... (271,780) Common Stock: $0.001 par value; 15,000,000 shares authorized; 5,244,274 shares issued and outstanding.... 5,244 Additional paid-in capital................................ 1,404,036 Deficit accumulated during the development stage.......... (6,310,972) ----------- Total stockholders' deficit.......................... (5,171,622) ----------- Total liabilities and stockholders' deficit.......... $ 3,481,264 ===========
The accompanying notes are an integral part of these financial statements. F-33 97 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF OPERATIONS
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Net revenues................................................ $ 296,514 Cost of net revenues........................................ (16,501) ----------- Gross profit................................................ 280,013 Operating expenses: Research and development.................................. (3,116,105) Sales and marketing....................................... (1,767,442) General and administrative................................ (1,116,259) ----------- Total operating expenses............................. (5,999,806) ----------- Loss from operations........................................ (5,719,793) Interest income............................................. 36,487 Interest expense............................................ (310,488) Other income (expense), net................................. (316,378) ----------- Loss before provision for income tax........................ (6,310,172) Provision for income tax.................................... (800) ----------- Net loss.................................................... $(6,310,972) ===========
The accompanying notes are an integral part of these financial statements. F-34 98 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF STOCKHOLDERS' DEFICIT PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998
CONVERTIBLE PREFERRED STOCK DEFICIT ------------------------------------- ACCUMULATED SERIES A SERIES B COMMON STOCK ADDITIONAL DURING THE ---------------- ------------------ ------------------ PAID-IN UNEARNED DEVELOPMENT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION STAGE ------- ------ --------- ------ --------- ------ ---------- ------------ ----------- Issuance of Series A Preferred Stock, Series B Preferred Stock and Common Stock in exchange for assets in March 1998............... 691,205 $691 1,238,390 $1,238 3,745,153 $3,745 $ 731,005 $ -- $ -- Exercise of Common Stock Options at $0.01 per share from March to July 1998............... -- -- -- -- 1,509,020 1,509 13,581 -- -- Repurchase of Preferred in April 1998............... (79,585) (79) -- -- -- -- (90,948) -- -- Repurchase of common stock at $0.01 per share from August to December 1998... -- -- -- -- (16,149) (16) (145) -- Unearned compensation....... -- -- -- -- -- -- 455,861 (455,861) -- Amortization of unearned compensation....... -- -- -- -- -- -- -- 184,081 -- Issuance of Series C Preferred Stock warrants in conjunction with the Comdisco loan (Note 5)........... -- -- -- -- -- -- 282,188 -- -- Exercise of Series A warrants at $0.00 per share in October 1998....... 7,060 -- -- -- -- -- -- -- -- Issuance of Common Stock at $2.00 per share in exchange for consulting services in November 1998...... -- -- -- -- 6,250 6 12,494 -- -- Net loss............. -- -- -- -- -- -- -- -- (6,310,972) ------- ---- --------- ------ --------- ------ ---------- --------- ----------- Balance at December 31, 1998........... 618,680 $612 1,238,390 $1,238 5,244,274 $5,244 $1,404,036 $(271,780) $(6,310,972) ======= ==== ========= ====== ========= ====== ========== ========= =========== TOTAL SHAREHOLDERS' DEFICIT ------------- Issuance of Series A Preferred Stock, Series B Preferred Stock and Common Stock in exchange for assets in March 1998............... $ 736,679 Exercise of Common Stock Options at $0.01 per share from March to July 1998............... 15,090 Repurchase of Preferred in April 1998............... (91,027) Repurchase of common stock at $0.01 per share from August to December 1998... (161) Unearned compensation....... -- Amortization of unearned compensation....... 184,081 Issuance of Series C Preferred Stock warrants in conjunction with the Comdisco loan (Note 5)........... 282,188 Exercise of Series A warrants at $0.00 per share in October 1998....... -- Issuance of Common Stock at $2.00 per share in exchange for consulting services in November 1998...... 12,500 Net loss............. (6,310,972) ----------- Balance at December 31, 1998........... $(5,171,622) ===========
The accompanying notes are an integral part of these financial statements. F-35 99 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF CASH FLOWS
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Cash flows from operating activities: Net loss.................................................. $(6,310,972) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Accretion on warrants................................ 23,777 Depreciation and amortization........................ 244,839 Amortization of stock-based compensation............. 184,081 Issuance of common stock for consulting services..... 12,500 Changes in current assets and liabilities: Prepaid expenses and other current assets......... 68,948 Accounts payable.................................. 229,971 Accrued liabilities............................... 305,233 Deferred revenue.................................. 126,134 ----------- Net cash used in operating activities........... (5,115,489) ----------- Cash flows from financing activities: Proceeds from issuance of common stock.................... 15,090 Cost of repurchase of common stock........................ (91,188) Principal payments on capital lease obligations........... (67,249) Proceeds from notes payable............................... 7,500,000 Increase in restricted cash............................... (76,423) ----------- Net cash provided by financing activities....... 7,280,230 ----------- Net increase in cash and cash equivalents................... 2,164,741 Cash and cash equivalents at beginning of period............ -- ----------- Cash and cash equivalents at end of period.................. $ 2,164,741 =========== Supplemental cash flow information: Cash paid for income taxes................................ $ 800 =========== Cash paid for interest.................................... $ 81,786 =========== Supplemental non-cash investing and financing activity: Property and equipment acquired under capital leases...... $ 755,802 =========== Issuance of common stock for consulting services.......... $ 12,500 ===========
Assets and liabilities transferred from Capital Technology, Inc. (see Note 2). The accompanying notes are an integral part of these financial statements. F-36 100 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Foglight Software, Inc. (the "Company"), was incorporated in November 1997 in the state of Delaware to develop, market and sell software tools that are used by network professionals to diagram, document and manage network environments. Products are sold directly to end users in North America, primarily through its sales organization. Since its formation the Company has been in the development stage with its principal activities consisting of recruiting personnel, developing its initial technology and raising capital. In March 1999, the Company changes its name from Resolute Software to Foglight Software Inc. BASIS OF PRESENTATION The financial statements have been prepared assuming the Company will continue as a going concern. The Company has sustained losses from operations since the Company's inception in November 1997, related primarily to the development of its products. In 1999, the Company's management plans to fund working capital requirements through additional financing, which the Company is seeking. The Company's continued existence is dependent on obtaining this financing or achieving profitable operations. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION Under SOP 97-2, product license revenue is recognized upon shipment, if a signed contract exists, the fee if fixed and determinable, collection of resulting receivable is probable and product returns are reasonably estimable. For contracts with multiple elements (e.g. product licenses maintenance, and other services), in which the Company does not have objective evidence of fair value for each component, the Company must recognize revenue ratably over the period of the contract for which services will be provided. Service revenue consists primarily of maintenance, training and consulting services. Maintenance revenues are recognized ratably over the maintenance period, which is generally one year. Revenue for training and consulting services are recognized as the services are performed. CERTAIN RISKS AND CONCENTRATIONS Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, and accounts receivable. The Company performs limited credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. For the period from November 10, 1997 (date of inception) to December 31, 1998, two customers accounted for 61.7% and 11.8% respectively of the Company's revenues. F-37 101 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS The Company's products are concentrated in a single segment in the software industry which is characterized by rapid technological advances, changes in customer requirements and evolving industry standards. The success of the Company depends on management's ability to anticipate and respond quickly and adequately to technological developments in the industry, changes in customer requirements or changes in industry standards. Any significant delays in the development or introduction of products or services could have a material adverse effect on the Company's business and operating results. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts payable and other accrued liabilities approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for leases and notes payable with similar terms, the carrying value of its lease and notes payable obligations approximates fair value. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company's cash and cash equivalents are maintained in accounts with one U.S. financial institution. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. RESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred. Software development costs are capitalized beginning when a product's technological feasibility has been established and ending when a product is available for general release to customers. The Company has not capitalized any software development costs to date as such costs have not been material. INCOME TAXES Income taxes are recorded under the liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. COMPREHENSIVE INCOME The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires the disclosure of comprehensive income and its components in a full set of general purpose financial statements or on the statement of operations. Comprehensive income is defined as net income plus revenues, expenses, gains and losses that, under generally accepted accounting principles, are excluded from net income. For the period ended December 31, 1998, there are no material differences between comprehensive income and net income. F-38 102 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB No. 25") and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). The new standard requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives should be reported in the statement of operations or as a deferred item, depending on the use of derivatives and whether they qualify for hedge accounting. The key criterion for hedge accounting is that the derivative must be highly effective in achieving offsetting changes in fair value of cash flows of the hedged items during the term of the hedge. SFAS No. 133 will be effective for fiscal years beginning after June 15, 2000. Currently, the Company does not hold derivative instruments or engage in hedging activities. 2. INITIAL FUNDING FROM CAPITAL TECHNOLOGIES INTEGRATION, INC. On March 16, 1998 the Company received certain assets and liabilities from Capital Technologies Integration, Inc. in exchange for an issuance of stock to Capital Technologies Integration, Inc. The exchange was recorded at historical cost since there was no change in ownership. The historical cost of the net assets received are as follows: Accounts receivable......................................... $259,721 Other current assets........................................ 33,203 -------- 292,924 Property and equipment...................................... 505,161 -------- Total assets......................................... 798,085 Accrued liabilities......................................... 61,406 -------- Net assets........................................... $736,679 ========
In addition, Capital Technologies Integration, Inc. loaned $1,500,000 to the Company (see Note 5). 3. BALANCE SHEET COMPONENTS
DECEMBER 31, 1998 ------------ Property and equipment, net: Computer equipment........................................ $1,080,343 Furniture and fixtures.................................... 180,620 ---------- 1,260,963 Less: Accumulated depreciation and amortization........... (244,839) ---------- $1,016,124 ==========
F-39 103 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS Property and equipment includes $755,802 of computer equipment and internal-use software under capital leases at December 31, 1998. Accumulated depreciation and amortization of assets under capital leases totaled $94,660 at December 31, 1998.
DECEMBER 31, 1998 -------------- Accrued liabilities: Payroll and related expenses.............................. $122,379 Accrued interest expense.................................. 73,500 Other..................................................... 39,335 -------- $235,214 ========
4. INCOME TAXES The provision for income taxes consists of the following:
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Current: State and local........................................... $800 ---- $800 ====
Deferred tax assets and liabilities consist of the following:
DECEMBER 31, 1998 ------------ Deferred tax assets: Net operating loss carryforwards.......................... $ 2,118,855 Accruals and reserves..................................... 82,855 Capitalized start up costs................................ 199,905 Depreciation and amortization............................. 2,601 Deferred revenue.......................................... 33,859 ----------- 2,438,075 ----------- Net deferred tax assets..................................... 2,438,075 Valuation allowance......................................... (2,438,075) ----------- $ -- ===========
Management believes that, based on cumulative losses, it is more likely than not that the deferred tax assets will not be utilized, such that a full valuation allowance has been recorded. At December 31, 1998, the Company had approximately $5,319,000 of federal and state net operating loss carryforwards available to offset future taxable income which expire in varying amounts beginning in 2018 and 2006, respectively. The Company's net operating loss carryforwards may be subject to certain limitations on annual utilization attributable to equity transactions that result in changes in ownership, as defined by the Tax Reform Act of 1986. F-40 104 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 5. BORROWINGS EQUIPMENT LEASE LINE At December 31, 1998, the Company had $695,291 outstanding and due under equipment lease financing lines with the leasing companies Phoenix Leasing and Comdisco Inc. The equipment lease lines provide for borrowings of up to $1,250,552 which are collateralized by the leased equipment. The financing lines expire in September 2001 and December 2002, respectively, and charges interest at rates of 18.13% and 18.59% per annum, respectively. In conjunction with the Comdisco lease line, the Company issued warrants to purchase 1,750 shares of Series C preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The leases contain various covenants which the Company has not fully complied with but which have been waived by the leasing companies. NOTES PAYABLE Notes payable consists of the following:
DECEMBER 31, 1998 ------------ 5.88% Convertible notes: matures July 24, 2008..................................... $ 3,000,000 10.50% Captech note: matures March 16, 2008.................................... 1,624,687 11.50% Comdisco note; matures September 30, 2001................................ 2,741,589 ----------- 7,366,276 Less: Current portion....................................... (3,303,137) ----------- $ 4,063,139 ===========
CONVERTIBLE NOTE The entire principal and accrued interest on the convertible notes are convertible into 1,500,000 shares of Series C preferred stock of the Company at the option of the holder in a ten day period following the closing of the next sale of the Company's equity. The notes were converted into Series C preferred stock in May 1999. There is interest in arrears on the notes of $73,500. CAPTECH NOTE Under an agreement signed with Capital Technologies Integration, Inc. on March 16, 1998, the $1,500,000 Promissory Note shall terminate, and the obligation of the Company to make payment on the unpaid principal and accrued interest due shall be forgiven in full, on the date of the earlier to occur of (i) the consummation of the Company's initial sale of its Common Stock in a bona fide commitment underwriting pursuant to a registration statement on Form S-1 (or successor form) under the Securities Act (other than a registration statement relating either to the sale of securities to the Company's employees pursuant to a stock option, stock purchase or similar plan or a SEC Rule 145 transaction) provided that such public offering establishes a valuation for the Company of at least $75,000,000, or F-41 105 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS (ii) upon a change of control, provided such a change of control establishes a valuation for the Company of at least $75,000,000. For the purposes of this note, a "change of control" means to sell, convey, or otherwise dispose of or encumber all or substantially all of its property, or business or consolidate with any other corporation or effect any transactions or series of related transactions which dispose of more than 50% of the voting power of the Company. There is interest in arrears of $124,687. COMDISCO NOTE In conjunction with the Comdisco note the Company issued warrants to purchase 187,500 shares of Series C preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The warrants issued have a fair value of 1.55 per warrant, at the time of issuance, using the Black-Scholes pricing model. The aggregate fair value of these warrants of approximately $282,188 has been, recorded as a discount on the debt and will be amortized to interest expense over the life of the note which is three years. The amortization for the period from November 10, 1997 (date of inception) to December 31, 1998 is $23,777. The Loan is collateralized by substantially all the assets of the Company not collateralized by the lease lines. The notes are subject to certain covenants that the Company is not currently in compliance with, however, the lender has currently waived its covenants. Principal payments under notes payable are as follows: Year Ending December 31, 1999...................................................... $ 397,200 2000...................................................... 1,286,704 2001...................................................... 1,316,096 2002...................................................... -- 2003...................................................... -- Thereafter................................................ 4,500,000 ---------- $7,500,000 ==========
6. COMMITMENTS PURCHASE COMMITMENTS At December 31, 1998, the Company had approximately $72,000 in noncancelable purchase commitments with suppliers. The Company expects to sell all products which it has committed to purchase from suppliers. LEASES The Company leases office space and equipment under noncancelable operating and capital leases with various expiration dates through 2002. Rent expense for the period from November 10, 1997 (date of inception) to December 31, 1998 was $179,869. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid. F-42 106 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS Future minimum lease payments under noncancelable operating and capital leases, including lease commitments entered into subsequent to December 31, 1998 are as follows:
CAPITAL OPERATING LEASES LEASES -------- ---------- Year Ending December 31, 1999...................................................... $253,888 $ 306,510 2000...................................................... 284,430 310,116 2001...................................................... 297,745 313,722 2002...................................................... 52,013 158,664 -------- ---------- Total minimum lease payments................................ 888,076 $1,089,012 ========== Less: Amount representing interest.......................... 192,785 -------- Present value of capital lease obligations.................. 695,291 Less: Current portion....................................... 155,980 -------- Long-term portion of capital lease obligations......... $539,311 ========
7. CONVERTIBLE PREFERRED STOCK Convertible Preferred Stock at December 31, 1998 consists of the following:
SHARES ------------------------- PROCEEDS NET OF SERIES AUTHORIZED OUTSTANDING ISSUANCE COSTS ------ ---------- ----------- --------------- A............................................. 710,029 618,680 $ 612 B............................................. 1,700,000 1,238,390 1,238 C............................................. 2,500,000 -- -- --------- --------- ------ 4,910,029 1,857,070 $1,850 ========= ========= ======
The holders of Convertible Preferred Stock have various rights and preferences as follows: VOTING Each holder of shares of Preferred Stock shall be entitled to the number of votes equal to an equivalent number of shares of Common Stock into which it is convertible and votes together as one class with the Common Stock. As long as at least 47,058 shares of Convertible Preferred Stock remain outstanding, the Company must obtain approval from a majority of the holders of Convertible Preferred Stock in order to alter the Articles of Incorporation as related to Convertible Preferred Stock, increase the authorized number of shares of Convertible Preferred Stock, authorize or issue any other equity security senior to or on a parity with the Series A, B or C preferred stock, repurchase any shares of Common Stock other than shares subject to the right of repurchase by the Company, sell all or substantially all the Company's assets in a single transaction or series of related transactions, authorize a dividend for any class or series other than Convertible Preferred Stock or effect a merger, consolidation or sale of assets where the existing shareholders retain less than 50% of the voting stock of the surviving entity. DIVIDENDS Holders of Series A, B and C Convertible Preferred Stock are entitled to receive noncumulative dividends at the per annum rate of $0.083215, $0.19125 and $0.16 per share, respectively, when and if F-43 107 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS declared by the Board of Directors. The holders of Series A, B and C Convertible Preferred Stock will also be entitled to participate in dividends on Common Stock, when and if declared by the Board of Directors, based on the number of shares of Common Stock held on an as-if converted basis. No dividends on Convertible Preferred Stock or Common Stock have been declared by the Board from inception through December 31, 1998. LIQUIDATION In the event of any liquidation, dissolution or winding up of the Company, including a merger, or acquisition that results in the transfer of 50% or more of the outstanding voting power of the Company or a sale of substantially all of the assets of the Company, the holders of Series A, B and C Convertible Preferred Stock are entitled to receive an amount per share equal to (i) the applicable Original Issue Price for such series of Convertible Preferred Stock, plus (ii) all declared but unpaid dividends thereon, plus (iii) for the Series B Convertible Preferred Stock only, an additional amount per share equal to $0.8075 (as adjusted for any stock splits, stock dividends, recapitalizations or the like) and (iv) for the Series C Convertible Preferred Stock only, an additional amount per share equal to $0.6667 (as adjusted for any stock splits, stock dividends, recapitalizations or the like). The remaining assets, if any, shall be distributed among the holders of the then outstanding Common Stock pro rata, according to the number of shares of Common Stock held by each holder thereof. Should the Company's legally available assets be insufficient to satisfy the liquidation preferences, the funds will be distributed ratably among holders of the Series A, B and C Convertible Preferred Stock preferences, so that each holder receives the same percentage of the applicable preferential amount. CONVERSION Each share of Series A, B and C Convertible Preferred Stock is convertible, at the option of the holder, according to a conversion ratio, subject to adjustment for dilution. Each share of Series A, B and C Convertible Preferred Stock automatically converts into the number of shares of Common Stock into which such shares are convertible at the then effective conversion ratio upon: (1) immediately prior to the closing of a public offering of Common Stock with the aggregate public offering price of at least $8.00 per share and with gross proceeds of at least $10,000,000 and (2) upon the Company's receipt of the written consent of the holders of not less than a majority of outstanding Convertible Preferred Stock. WARRANTS FOR CONVERTIBLE PREFERRED STOCK There is a further commitment to issue 11,763 shares of Series A Convertible Preferred Stock for no consideration per share upon the exercise of a warrant to purchase stock of Capital Technologies Integration, Inc. which shares are issuable as dividend on the Capital Technologies Integration, Inc. stock underlying the warrant. 8. COMMON STOCK The Company's Articles of Incorporation, as amended, authorize the Company to issue 15,000,000 shares of $0.01 par value Common Stock. A portion of the shares sold are subject to a right of repurchase by the Company subject to vesting, which is generally over a four year period from the earlier of grant date or employee hire date, as applicable, until vesting is complete. At December 31, 1998, there were 1,378,623 shares subject to repurchase. F-44 108 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 9. STOCK OPTION PLANS In March 13, 1998, the Company adopted the 1998 Stock Option Plan (the "Plan"). The Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the Plan may be either incentive stock options or nonqualified stock options. Incentive stock options ("ISO") may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options ("NSO") may be granted to Company employees and consultants. The Company has reserved 1,735,000 shares of Common Stock for issuance under the Plan. Options under the Plan may be granted for periods of up to ten years and at prices no less than 85% of the estimated fair value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO and NSO shall not be less than 100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant, respectively. Options are exercisable immediately subject to repurchase options held by the Company which lapse over a maximum period of four years at such times and under such conditions as determined by the Board of Directors. To date, options granted generally vest over four years.
SHARES NUMBER WEIGHTED AVAILABLE OF OPTIONS AVERAGE FOR GRANT OUTSTANDING PRICE TOTAL ---------- ----------- -------- -------- Initial shares reserved........................ 1,735,000 -- $ -- $ -- Options granted.............................. (1,914,743) 1,914,743 0.02 43,182 Shares issued from option pool............... (6,250) -- -- -- Options exercised............................ -- (1,509,020) 0.01 (15,090) Options canceled............................. 201,299 (201,299) 0.02 (4,008) ---------- ---------- -------- Balances at December 31, 1998.................. 15,306 204,424 $0.12 $ 24,084 ========== ========== ========
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation ("SFAS No. 123")." The Company however, continues to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for the Plan. Accordingly, no compensation cost has been recognized for the Plan. Determination of compensation cost for the Plan based on the fair value at the grant date for awards in 1998 consistent with the provisions of SFAS No. 123, would not result in a significant difference from the reported net loss for the period from November 10, 1997 (date of inception) to December 31, 1998. The fair value of each option grant is estimated on the date of grant using the minimum value method assuming an expected life of four years and a risk-free interest rate of 4.62% to 5.89%. The weighted average expected life was calculated based on the vesting period and the expected exercise behavior of options granted. The risk-free interest rate was calculated in accordance with the grant date and expected life calculated of options granted. In connection with certain stock option grants during the year ended December 31, 1998, the Company recorded stock-based compensation totaling $455,861, which is being amortized in accordance with FASB Interpretation No. 28 over the vesting periods of the related options, which is generally four years. Stock-based compensation amortization recognized during the year ended December 31, 1998 totaled $184,081. F-45 109 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS The weighted average fair value of the options granted was $0.02 in the period from November 10, 1997 (date of inception) to December 31, 1998.
DECEMBER 31, 1998 ------------------------------------------------------------- OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE EXERCISE PRICE OUTSTANDING LIFE PRICE OUTSTANDING PRICE -------------- ----------- ----------- -------- ----------- -------- $0.01 -- 0.20.................................... 204,424 9.6 $0.12 204,424 $0.12
10. SUBSEQUENT EVENTS On January 13, 1999, the Company increased the shares reserved under the 1998 plan to a total of 2,000,000 shares. On April 28, 1999 the Company increased the shares reserved under the 1998 plan to a total of 2,500,000 shares. In February 1999, the Company instituted a change of control agreement whereby in the event of a change of control unvested employee stock options vest, and repurchase rights lapse, by 25%. If after a change of control the individual is involuntarily terminated the stock options vest, and repurchase rights lapse, by an additional 25%. On March 31, 1999, the Board authorized that shares of Series C Convertible Preferred Stock increase to a total of 3,189,250. On April 28, 1999, the Board authorized that the shares of Series C Convertible Preferred Stock and Common Stock increase to a total of 4,789,250 and 16,600,000, respectively. In April 1999, the Company issued 1,000,000 shares of Series C Convertible Preferred Stock, along with warrants for 499,995 shares of Series C Convertible Preferred Stock, for $2,000,000. In July 1999 and October 1999, the Company issued an aggregate of $1,000,000 of promissory notes convertible into shares of Series C Convertible Preferred Stock along with warrants for 249,994 shares of Series C Convertible Preferred Stock. The warrants terminate upon the earliest of September 30, 2004 or the sale of the business and have an exercise price of $2.00. F-46 110 INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors Foglight Software, Inc. We have audited the accompanying balance sheet of Foglight Software, Inc. (the Company) as of December 31, 1999, and the related statements of operations, capital deficiency, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Foglight Software, Inc. at December 31, 1999, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 22, 2000 F-47 111 FOGLIGHT SOFTWARE, INC. BALANCE SHEET
DECEMBER 31, 1999 ------------ ASSETS Current Assets: Cash and cash equivalents................................. $ 32,589 Restricted cash........................................... 50,655 Accounts receivable, net of allowance for doubtful accounts of $1,070..................................... 106,514 Prepaid expenses and other current assets................. 200,058 ------------ Total current assets................................. 389,816 Property and equipment, net................................. 865,539 Other assets................................................ 34,344 ------------ $ 1,289,699 ============ LIABILITIES AND CAPITAL DEFICIENCY Current liabilities: Notes payable, current portion............................ $ 4,747,196 Accounts payable.......................................... 79,669 Accrued liabilities....................................... 752,012 Deferred revenue.......................................... 236,641 Capital lease obligations, current portion................ 309,871 ------------ Total current liabilities............................ 6,125,389 Notes payable, net of current portion..................... 1,279,205 Capital lease obligations, net of current portion......... 497,595 Commitments and contingencies (Note 6) Capital deficiency: Series A convertible preferred stock, $0.001 par value, 710,029 shares authorized; 618,680 shares issued and outstanding............................................ 612 Series B convertible preferred stock, $0.001 par value, 1,700,000 shares authorized; 1,238,390 shares issued and outstanding........................................ 1,238 Series C convertible preferred stock, $0.001 par value, 4,789,250 shares authorized; 2,500,000 shares issued and outstanding........................................ 2,500 Common stock, $0.001 par value, 16,600,000 shares authorized; 5,510,592 shares issued and outstanding.... 5,510 Warrants to purchase Series C convertible preferred stock.................................................. 1,292,188 Additional paid-in capital................................ 7,886,243 Unearned compensation expense............................. (1,388,251) Accumulated deficit....................................... (14,412,530) ------------ Net capital deficiency............................... (6,612,490) ------------ $ 1,289,699 ============
See accompanying notes to financial statements. F-48 112 FOGLIGHT SOFTWARE, INC. STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 Revenue: Licenses.................................................. $ 2,433,107 Services.................................................. 382,879 ----------- Total revenue.......................................... 2,815,986 Cost of revenue: Licenses.................................................. 108,458 Services.................................................. 207,430 ----------- Total cost of revenue....................................... 315,888 ----------- Gross profit................................................ 2,500,098 Operating expenses: Sales and marketing....................................... 3,733,771 Research and development.................................. 3,680,185 General and administrative................................ 1,233,377 Other compensation expense................................ 409,053 ----------- Total operating expenses............................. 9,056,386 ----------- Loss from operations........................................ (6,556,288) Other expense, net.......................................... (865,267) ----------- Loss before income tax provision............................ (7,421,555) Income tax provision........................................ 900 ----------- Net loss.................................................... (7,422,455) Value of beneficial conversion feature...................... 660,000 Accretion on preferred stock................................ 19,103 ----------- Net loss applicable to common stockholders.................. $(8,101,558) ===========
See accompanying notes to financial statements. F-49 113 FOGLIGHT SOFTWARE, INC. STATEMENT OF CAPITAL DEFICIENCY
WARRANTS TO PURCHASE CONVERTIBLE SERIES C PREFERRED STOCK COMMON STOCK CONVERTIBLE ADDITIONAL ------------------ ------------------ PREFERRED PAID-IN UNEARNED ACCUMULATED SHARES AMOUNT SHARES AMOUNT STOCK CAPITAL COMPENSATION DEFICIT --------- ------ --------- ------ ----------- ---------- ------------ ------------ BALANCE, January 1, 1999..... 1,857,070 $1,850 5,244,274 $5,244 $ 282,188 $1,121,848 $ (271,780) $ (6,310,972) Issuance of Series C preferred stock and warrants, net.............. 1,000,000 1,000 -- -- 660,000 1,980,897 -- (660,000) Issuance of Series C preferred stock warrants in conjunction with a financing.................. -- -- -- -- 350,000 -- -- -- Accretion on preferred stock...................... -- -- -- -- -- 19,103 -- (19,103) Conversion of debt to equity..................... 1,500,000 1,500 -- -- -- 3,116,100 -- -- Exercise of stock options.... -- -- 701,440 701 -- 127,257 -- -- Repurchase of common stock... -- -- (435,122) (435) -- (4,486) -- -- Unearned compensation........ -- -- -- -- -- 1,525,524 (1,525,524) -- Amortization of unearned compensation............... -- -- -- -- -- -- 409,053 -- Net loss..................... -- -- -- -- -- -- -- (7,422,455) --------- ------ --------- ------ ---------- ---------- ----------- ------------ BALANCE, December 31, 1999... 4,357,070 $4,350 5,510,592 $5,510 $1,292,188 $7,886,243 $(1,388,251) $(14,412,530) ========= ====== ========= ====== ========== ========== =========== ============ NET CAPITAL DEFICIENCY ----------- BALANCE, January 1, 1999..... $(5,171,662) Issuance of Series C preferred stock and warrants, net.............. 1,981,897 Issuance of Series C preferred stock warrants in conjunction with a financing.................. 350,000 Accretion on preferred stock...................... Conversion of debt to equity..................... 3,117,600 Exercise of stock options.... 127,958 Repurchase of common stock... (4,921) Unearned compensation........ -- Amortization of unearned compensation............... 409,053 Net loss..................... (7,422,455) ----------- BALANCE, December 31, 1999... $(6,612,490) ===========
See accompanying notes to financial statements. F-50 114 FOGLIGHT SOFTWARE, INC. STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1999 ------------ Cash flows from operating activities: Net loss.................................................. $(7,422,455) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of debt discount........................ 214,277 Depreciation......................................... 483,595 Amortization of unearned compensation expense........ 409,053 Changes in current assets and liabilities: Accounts receivable............................... (106,514) Prepaid expenses and other current assets......... (10,426) Accounts payable.................................. (150,302) Accrued liabilities............................... 516,798 Deferred revenue.................................. 110,507 ----------- Net cash used in operating activities........... (5,955,467) Cash flows from investing activities: Purchases of property and equipment....................... (105,927) Cash flows from financing activities: Proceeds from issuance of common stock.................... 127,958 Proceeds from issuance of Series C preferred stock........ 1,981,897 Repurchase of common stock................................ (4,921) Principal payments on capital lease obligations and notes payable................................................ (612,626) Proceeds from notes payable............................... 2,411,166 Decrease in restricted cash............................... 25,768 ----------- Net cash provided by financing activities....... 3,929,242 ----------- Net decrease in cash and cash equivalents................... (2,132,152) Cash and cash equivalents, beginning of period.............. 2,164,741 ----------- Cash and cash equivalents, end of period.................... $ 32,589 =========== Supplemental cash flow information -- cash paid for: Income taxes.............................................. $ 900 =========== Interest.................................................. $ 457,498 =========== Supplemental noncash investing and financing activities: Property and equipment acquired under capital leases...... $ 227,083 =========== Conversion of notes payable to Series C preferred stock... $ 3,117,600 =========== Value of beneficial conversion feature.................... $ 660,000 =========== Accretion on preferred stock.............................. $ 19,103 ===========
See accompanying notes to financial statements. F-51 115 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Nature of Operations -- Foglight Software, Inc. (the Company) was incorporated in November 1997 in the State of Delaware to develop, market and sell software tools that are used by network professionals to diagram, document, and manage network environments. Products are sold directly to end users in North America, primarily through its sales organization. In March 1999, the Company changed its name from Resolute Software to Foglight Software, Inc. In January 2000, the Company was purchased by Quest Software, Inc. (Quest) in exchange for 1,187,603 shares of Quest common stock valued at $104,167,628, cash payments estimated to be $437,000, the assumption of unvested Foglight stock options valued at $2,199,794 and the assumption of net liabilities of $4,066,237. Fair Value of Financial Instruments -- The carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accounts payable, and other accrued liabilities, approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for leases and notes payable with similar terms, the carrying value of its lease and notes payable obligations approximates fair value. Cash, Cash Equivalents and Restricted Cash -- The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The restricted cash consists of cash required to be maintained in connection with the Company's lease of its operating facility. Property and Equipment -- Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. Repair and maintenance costs are expensed as incurred. Revenue Recognition -- Under Statement of Position (SOP) No. 97-2, Software Revenue Recognition, license revenue is recognized upon shipment, if a signed contract exists, the fee is fixed and determinable, collection of resulting receivable is probable, and product returns are reasonably estimable. If the provisions of SOP No. 97-2 are not met, the revenue is deferred. Service revenue consists primarily of maintenance, training, and consulting services. Maintenance revenues are recognized ratably over the maintenance period, which is generally one year. Revenue for training and consulting services are recognized as the services are performed. Research and Development -- Research and development costs are expensed as incurred. Software development costs are capitalized, beginning when a product's technological feasibility has been established and ending when a product is available for general release to customers. Because the Company believes that its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no software development costs have been capitalized as of December 31, 1999. F-52 116 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) Income Taxes -- The Company accounts for its income taxes under the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Deferred taxes on income result from temporary differences between the reporting of income for financial statements and tax reporting purposes. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Stock-Based Compensation -- The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and complies with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Comprehensive Income -- There was no difference between the net loss and the comprehensive net loss for the year ended December 31, 1999. Certain Risks and Concentrations -- Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, and accounts receivable. The Company performs limited credit evaluations of its customers' financial conditions and, generally, requires no collateral from its customers. For the year ended December 31, 1999, three customers accounted for 23%, 12%, and 10%, respectively, of the Company's revenues. The loss of, or a reduction in sales to, any of these customers could have a material adverse effect on the Company's business, operating results and financial condition. The Company's products are concentrated in a single segment in the software industry, which is characterized by rapid technological advances, changes in customer requirements and evolving industry standards. The success of the Company depends on management's ability to anticipate and respond quickly and adequately to technological developments in the industry, changes in customer requirements or changes in industry standards. Any significant delays in the development or introduction of products or services could have a material adverse effect on the Company's business and operating results. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements -- In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which the Company is required to adopt effective in its fiscal year 2001. SFAS No. 133 will require the Company to record all derivatives on the balance sheet at fair value. The Company does not currently engage in hedging activities, but will continue to evaluate the effects of adopting SFAS No. 133. F-53 117 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. PROPERTY AND EQUIPMENT, NET Property and equipment consist of the following: Computer equipment.......................................... $1,410,883 Furniture and fixtures...................................... 181,720 ---------- 1,592,603 Less accumulated depreciation............................... (727,064) ---------- $ 865,539 ==========
Property and equipment includes $1,100,018 of computer equipment and software under capital leases at December 31, 1999. Accumulated depreciation of assets under capital leases totaled $517,499 at December 31, 1999. 3. ACCRUED LIABILITIES Accrued liabilities consist of the following: Payroll and related costs................................... $388,423 Accrued interest............................................ 290,480 Other....................................................... 73,109 -------- $752,012 ========
4. INCOME TAXES The provision for income taxes consists of the following: Current: State and local........................................... $ 900 Deferred: Federal................................................... 2,419,811 State..................................................... 753,457 ----------- Net deferred taxes.......................................... 3,173,268 Valuation allowance......................................... (3,173,268) ----------- $ 900 ===========
F-54 118 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) Deferred tax assets and liabilities consist of the following: Deferred tax assets: Net operating loss carryforwards.......................... $ 4,694,000 Accruals and reserves..................................... 237,000 Capitalized start-up costs................................ 216,000 Depreciation and amortization............................. (18,000) Tax credits............................................... 309,000 ----------- Net deferred tax assets..................................... 5,438,000 Valuation allowance......................................... (5,438,000) ----------- $ -- ===========
The Company evaluates a variety of factors in determining the amount of deferred income assets to be recognized pursuant to SFAS No. 109, Accounting for Income Taxes. During 1999, the Company determined that a valuation allowance for the entire net deferred tax asset is required. As of December 31, 1999, the Company has approximately $11,900,000 and $12,000,000 of federal and state domestic net operating loss carryforwards, respectively, which begin expiring on an annual basis in 2018 and 2006, respectively. 5. BORROWINGS Equipment Lease Line -- At December 31, 1999, the Company had $807,466 outstanding and due under equipment lease financing lines with the leasing companies, Phoenix Leasing and Comdisco Inc. (Comdisco). The equipment lease lines provide for borrowings of up to $1,250,552 which are collateralized by the leased equipment. The financing lines expire in September 2001 and December 2002, respectively. In conjunction with the Comdisco lease line, the Company issued warrants in 1998 to purchase 1,750 shares of Series C preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The fair value of these warrants was determined to be insignificant using the Black-Scholes option-pricing model and no value was ascribed to these warrants. All of the warrants were outstanding at December 31, 1999. In April 1999, in connection with the issuance of 1,000,000 shares of Series C convertible preferred stock (Note 7), $3,000,000 in previously outstanding convertible notes were converted into 1,500,000 shares of Series C convertible preferred stock. F-55 119 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) Notes Payable -- Notes payable consists of the following: 5.32% Convertible Subordinated Promissory Notes, payable on demand by the holders at any time one year after date of issuance.................................................. $ 764,065 10.5% Captech note; matures March 16, 2008.................. 1,500,000 11.5% Comdisco Inc. note; matures September 30, 2001........ 2,462,336 7.0% Quest Software, Inc. notes............................. 1,300,000 ----------- 6,026,401 Less current portion........................................ (4,747,196) ----------- $ 1,279,205 ===========
Convertible Subordinated Promissory Notes -- During April and October of 1999, the Company issued $1,000,000 of Convertible Subordinated Promissory Notes (Promissory Notes), which are payable, plus interest at 5.32%, on demand by the holders at any time one year from the date of issuance. The Promissory Notes are convertible upon any one of the following events: - Upon the close of an equity financing yielding gross proceeds of at least $3.0 million to the Company, the Promissory Notes will be converted into similar equity securities issued in conjunction with the financing - Upon the acquisition of the Company, the Promissory Notes will be converted into shares of the Company's Series C convertible preferred stock at a price of $2.00 per share - Upon a public offering of the Company's common stock under the Securities Act of 1933, the Promissory notes will be converted into shares of common stock at a price of $2.00 per share In conjunction with the acquisition of the Company by Quest in January 2000, the Promissory Notes were converted into Series C convertible preferred stock. In connection with the issuance of the Promissory Notes, the Company issued warrants to purchase 249,994 shares of Series C convertible preferred stock at a price of $2.00 per share. The Company has determined the relative fair value of the notes and warrants to be $650,000 and $350,000, respectively. The fair value of the warrants has been recorded as a discount on the debt and is being amortized over the one-year term of the notes. Captech Note -- Under an agreement signed with Capital Technologies Integration, Inc. (Captech) on March 16, 1998, the $1,500,000 promissory note shall terminate, and the obligation of the Company to make payment on the unpaid principal and accrued interest due shall be forgiven in full, on the date of the earlier to occur of (i) the consummation of the Company's initial sale of its common stock in a bona fide commitment underwriting pursuant to a Registration Statement on Form S-1 (or successor form) under the Securities Act (other than a Registration Statement relating either to the sale of securities to the Company's employees pursuant to a stock option, stock purchase or similar plan or a SEC Rule 145 transaction) provided that such public offering establishes a valuation for the Company of at least $75 million or (ii) upon a change of control, provided such a change of control establishes a valuation for the Company of at least $75 million. For purposes of this note, a "change of control" means to sell, convey, or otherwise dispose of or encumber all or substantially all of its property or business, or F-56 120 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) consolidate with any other corporation or effect any transactions or series of related transactions which dispose of more than 50% of the voting power of the Company. Included in accrued expenses, in the accompanying financial statements, is interest in arrears of $282,187 associated with the Captech note. The Captech note and related interest of approximately $272,000 was forgiven by the holder in conjunction with the acquisition of the Company by Quest in January 2000. Comdisco Note -- In conjunction with the issuance of the Comdisco note in 1998, the Company issued warrants to purchase 187,500 shares of Series C convertible preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The warrants issued have a fair value of $1.55 per warrant, at the time of issuance, using the Black-Scholes pricing model. The aggregate fair value of these warrants of approximately $282,188 has been recorded as a discount on the debt and will be amortized to interest expense over the life of the note which is three years. The amortization expense for the year ended December 31, 1999, was $117,948. The loan is collateralized by substantially all the assets of the Company not collateralized by the lease lines. Quest Notes -- In connection with certain provisions of a merger agreement signed between the Company and Quest during November 1999, the Company received advances totaling $1.3 million. The advances bore interest at 7%, and all principal and interest was due upon termination of the merger agreement or upon failure of the Company to satisfy certain conditions under the terms of the merger agreement. Upon completion of the acquisition of the Company by Quest in January 2000, the notes and accrued interest were assumed by Quest. Remaining principal payments under notes payable are as follows: Year ending December 31: 2000................................................. $4,747,196 2001................................................. 1,279,205 ---------- $6,026,401 ==========
6. COMMITMENTS Purchase Commitments -- At December 31, 1999, the Company had approximately $72,000 in noncancelable purchase commitments with suppliers. The Company expects to sell all products which it has committed to purchase from suppliers. Leases -- The Company leases office space and equipment under noncancelable operating and capital leases with various expiration dates through 2002. Rent expense for the year ended December 31, 1999, was $314,107. The Company recognizes rent expense on a straight-line basis over the lease period. F-57 121 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) Future minimum lease payments under noncancelable operating and capital leases, including lease commitments entered into subsequent to December 31, 1999, are as follows:
CAPITAL OPERATING LEASES LEASES --------- --------- Year ending December 31: 2000................................................. $ 416,608 $310,116 2001................................................. 431,533 313,722 2002................................................. 125,998 158,664 --------- -------- Total minimum lease payments................................ 974,139 $782,502 ======== Less amount representing interest........................... (166,673) --------- Present value of capital lease obligations.................. 807,466 Less current portion........................................ (309,871) --------- Long-term portion of capital lease obligations.............. $ 497,595 =========
7. CONVERTIBLE PREFERRED STOCK In April 1999, the Company raised $1,980,897, net of offering costs, from the sale of 1,000,000 shares of Series C convertible preferred stock at $2.00 per share. In connection with this issuance, the Company issued warrants to purchase 499,995 shares of Series C convertible preferred stock for $2.00 per share. The Company ascribed $660,000 to these warrants, based on the relative fair value at the date of issuance. As a result of the Series C convertible preferred stock being immediately convertible, the Company recorded the value of the beneficial conversion feature because the issuance of such preferred stock resulted in a conversion value to common stock at less than its fair value of $660,000. Accretion on the Series C convertible preferred stock of $19,103 has also been recorded. The value of the beneficial conversion feature and accretion has been included as increases in the net loss applicable to common stockholders in the accompanying financial statements. In April 1999, the Company issued 1,500,000 shares of Series C convertible preferred stock at $2.00 per share upon the conversion of $3,000,000 in previously outstanding convertible notes (Note 5). The holders of convertible preferred stock have various rights and preferences as follows: Voting -- Each holder of shares of preferred stock shall be entitled to the number of votes equal to an equivalent number of shares of common stock into which it is convertible, and votes together as one class with the common stock. As long as at least 47,058 shares of convertible preferred stock remain outstanding, the Company must obtain approval from a majority of the holders of convertible preferred stock in order to alter the Articles of Incorporation as related to convertible preferred stock, increase the authorized number of shares of convertible preferred stock, authorize or issue any other equity security senior to or on a parity with the Series A, B, or C preferred stock, repurchase any shares of common stock, other than shares subject to the right of repurchase by the Company, sell all or substantially all of the Company's assets in a F-58 122 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) single transaction or series of related transactions, authorize a dividend for any class or series other than convertible preferred stock, or effect a merger, consolidation, or sale of assets where the existing shareholders retain less than 50% of the voting stock of the surviving entity. Dividends -- Holders of Series A, B and C convertible preferred stock are entitled to receive noncumulative dividends at the per annum rate of $0.083215, $0.19125 and $0.16 per share, respectively, when and if declared by the Board of Directors. The holders of Series A, B, and C convertible preferred stock will also be entitled to participate in dividends on common stock, when and if declared by the Board of Directors, based on the number of shares of common stock held on an as-if converted basis. No dividends on convertible preferred stock or common stock have been declared by the Board from inception through December 31, 1999. Liquidation -- In the event of any liquidation, dissolution, or winding up of the Company, including a merger, or acquisition that results in the transfer of 50% or more of the outstanding voting power of the Company or a sale of substantially all of the assets of the Company, the holders of Series A, B, and C convertible preferred stock are entitled to receive an amount per share equal to (i) the applicable original issue price for such series of convertible preferred stock, plus (ii) all declared but unpaid dividends thereon, plus (iii) for the Series B convertible preferred stock only, an additional amount per share equal to $0.8075 (as adjusted for any stock splits, stock dividends, recapitalizations or the like), and (iv) for the Series C convertible preferred stock only, an additional amount per share equal to $0.6667 (as adjusted for any stock splits, stock dividends, recapitalizations or the like). The remaining assets, if any, shall be distributed among the holders of the then outstanding common stock pro rata, according to the number of shares of common stock held by each holder thereof. Should the Company's legally available assets be insufficient to satisfy the liquidation preferences, the funds will be distributed ratably among holders of the Series A, B, and C convertible preferred stock preferences, so that each holder receives the same percentage of the applicable preferential amount. Conversion -- Each share of Series A, B, and C convertible preferred stock is convertible, at the option of the holder, according to a conversion ratio, subject to adjustment for dilution. Each share of Series A, B, and C convertible preferred stock automatically converts into the number of shares of common stock into which such shares are convertible at the then effective conversion ratio upon: (1) immediately prior to the closing of a public offering of common stock with the aggregate public offering price of at least $8.00 per share and with gross proceeds of at least $10,000,000, and (2) upon the Company's receipt of the written consent of the holders of not less than a majority of outstanding convertible preferred stock. Warrants for Convertible Preferred Stock -- In 1998, the Company made a commitment to issue 11,763 shares of Series A Convertible Preferred Stock for no consideration per share upon the exercise of a warrant to purchase stock of Capital Technologies Integration, Inc., which shares are issuable as dividend on the Capital Technologies Integration, Inc. stock underlying the warrant. The warrant was outstanding at December 31, 1999 and converted in connection with the acquisition of the Company by Quest in January 2000. F-59 123 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. COMMON STOCK The Company's Articles of Incorporation, as amended, authorize the Company to issue 16,600,000 shares of $0.01 par value common stock. A portion of the shares sold are subject to a right of repurchase by the Company subject to vesting, which is generally over a four-year period from the earlier of grant date or employee hire date, as applicable, until vesting is complete. At December 31, 1999, there were 1,142,142 shares subject to repurchase. 9. STOCK OPTION PLANS On March 13, 1998, the Company adopted the 1998 stock option plan (the Plan). The Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the Plan may be either incentive stock options or nonqualified stock options. Incentive stock options (ISO) may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options (NSO) may be granted to Company employees and consultants. The Company has reserved 2,500,000 shares of common stock for issuance under the Plan. Options under the Plan may be granted for periods of up to ten years and at prices no less than 85% of the estimated fair value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO and NSO shall not be less than 100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant. Options are exercisable immediately subject to repurchase options held by the Company, which lapse over a maximum period of four years at such times and under such conditions as determined by the Board of Directors. To date, options granted generally vest over four years. In February 1999, the Company instituted a change of control agreement, whereby, in the event of a change of control, unvested employee stock options vest and repurchase rights lapse by 25%. If after a change of control the individual is involuntarily terminated, the stock options vest and repurchase rights lapse by an additional 25%.
NUMBER OF WEIGHTED OPTIONS AVERAGE OUTSTANDING PRICE ----------- -------- Balance, January 1, 1999.................................... 204,424 $0.12 Options granted........................................... 934,511 $1.03 Options exercised......................................... (701,440) $0.18 Options canceled.......................................... (157,662) $0.20 -------- Balance, December 31, 1999.................................. 279,833 $2.95 ========
The weighted average fair value of the options granted for the year ended December 31, 1999, was $1.89. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The Company, however, continues to apply APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for the Plan. Accordingly, no compensation cost has been recognized for the Plan. F-60 124 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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: expected volatility of zero; risk-free interest rates of 6%; and expected lives of five years. Had compensation cost been determined using the provisions of SFAS No. 123, the Company's net loss attributable to common shareholders would have been $8,275,898. In connection with certain stock option grants during the years ended December 31, 1998 and 1999, below the then fair market value of the underlying common stock, the Company recorded deferred compensation expense of $455,861 and $1,525,524, respectively, which is amortized over the vesting periods of the related options, which is generally four years. Compensation expense amortization recognized during the year ended December 31, 1999, totaled $409,053.
OPTIONS OUTSTANDING AT DECEMBER 31, 1999 OPTIONS EXERCISABLE AT -------------------------------------- DECEMBER 31, 1999 WEIGHTED ----------------------- AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE PRICE OUTSTANDING LIFE PRICE OUTSTANDING PRICE - ------------------------------------ ----------- ----------- -------- ----------- -------- $0.01.............................. 28,818 8.35 $0.01 28,818 $0.01 $0.20 128,126 9.65 $0.20 128,126 $0.20 $6.50.............................. 122,889 9.90 $6.50 122,889 $6.50 ------- ------- 279,833 279,833 ======= =======
10. EMPLOYEE RETIREMENT SAVINGS PLAN The Company has an employee retirement savings plan (the Plan) which qualifies under Section 401(k) of the Internal Revenue Code and provides for discretionary matching contributions (as defined) by the Company. The Company made no matching contributions during the year ended December 31, 1999. F-61 125 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA INFORMATION (IN THOUSANDS, EXCEPT SHARE INFORMATION) On December 17, 1999 the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock and stock options of MBR Technologies, Inc. (MBR) in exchange for 93,471 shares of Quest Common Stock valued at $9,324, a cash payment of $1,314 and the assumption of net liabilities of $340. The acquisition was accounted for as a purchase and the results of MBR's operations were included in the Company's statement of operations from the date of acquisition. On January 7, 2000 the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock of Foglight Software, Inc. (Foglight) in exchange for 1,187,603 shares of Quest Common Stock valued at $104,168, estimated cash payments of $437, the assumption of unvested Foglight stock options valued at $2,200 and the assumption of net liabilities estimated to be $4,066. The acquisition will be accounted for as a purchase. The following unaudited pro forma balance sheet as of December 31, 1999 assumes that the acquisition of Foglight had occurred on December 31, 1999. The unaudited statement of operations includes the unaudited statement of operations of MBR for the period from January 1, 1999 to December 17, 1999 and the unaudited statement of operations of Foglight for the year ended December 31, 1999 and assumes that the acquisition of MBR and Foglight had occurred on January 1, 1999. The pro forma combined results of operations is presented for information purposes only, is based on historical information, and does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of the combined enterprise. F-62 126 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA BALANCE SHEET (IN THOUSANDS)
QUEST FOGLIGHT COMBINED SOFTWARE SOFTWARE TOTAL PRO FORMA DECEMBER 31, DECEMBER 31, DECEMBER 31, PRO FORMA DECEMBER 31, 1999 1999 1999 ADJUSTMENTS 1999 ------------ ------------ ------------ ----------- ------------ ASSETS Current assets: Cash and cash equivalents.................. $ 39,643 $ 32 $ 39,675 $ (437)(1) $ 39,238 Restricted cash............................ -- 51 51 -- 51 Short-term marketable securities........... 11,000 -- 11,000 -- 11,000 Accounts receivable, net................... 18,771 107 18,878 -- 18,878 Prepaid expenses and other current assets................................... 5,333 200 5,533 (1,308)(3) 4,225 -------- -------- -------- -------- -------- Total current assets................... 74,747 390 75,137 (1,745) 73,392 Property and equipment, net................ 7,179 866 8,045 -- 8,045 Long-term marketable securities............ 4,484 -- 4,484 -- 4,484 Purchased technology and software licenses, net...................................... 441 -- 441 5,100(1) 5,541 Goodwill and other intangibles............. 11,452 -- 11,452 102,677(1) 114,129 Deferred income taxes...................... 415 -- 415 3,094(1) 3,509 Other assets............................... 431 34 465 -- 465 -------- -------- -------- -------- -------- Total assets........................... $ 99,149 $ 1,290 $100,439 $109,126 $209,565 ======== ======== ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable, current portion............. $ -- $ 4,747 $ 4,747 $ (3,572)(3) $ 1,175 Accounts payable........................... 3,436 80 3,516 -- 3,516 Accrued compensation....................... 4,966 -- 4,966 -- 4,966 Other accrued expenses..................... 7,062 752 7,814 (282)(3) 7,532 Income taxes payable....................... 2,030 -- 2,030 -- 2,030 Deferred support revenue................... 13,932 236 14,168 -- 14,168 Deferred license revenue................... 4,651 -- 4,651 -- 4,651 Capital lease obligations, current portion.................................. -- 310 310 -- 310 -------- -------- -------- -------- -------- Total current liabilities.............. 36,077 6,125 42,202 (3,854) 38,348 -------- -------- -------- -------- -------- Notes payable, net of current portion...... -- 1,279 1,279 -- 1,279 Long-term liabilities...................... 403 498 901 -- 901 Shareholders' equity: Preferred stock............................ -- 4 4 (4)(2) -- Common stock and additional paid in capital.................................. 94,010 7,892 101,902 98,476(1)(2)(3) 200,378 Warrants to purchase Series C convertible preferred stock.......................... -- 1,292 1,292 (1,292)(2) -- Retained earnings (deficit)................ 1,864 (14,412) (12,548) 14,412(1) 1,864 Accumulated other comprehensive income (loss)................................... (26) -- (26) -- (26) Unearned compensation costs................ -- (1,388) (1,388) 1,388(1) -- Notes receivable from sale of common stock.................................... (3,115) -- (3,115) -- (3,115) Capital distribution in excess of basis in common stock............................. (30,064) -- (30,064) -- (30,064) -------- -------- -------- -------- -------- Total shareholders' equity (deficit)... 62,669 (6,612) 56,057 112,980 169,037 -------- -------- -------- -------- -------- Total liabilities and shareholders' equity.............................. $ 99,149 $ 1,290 $100,439 $109,126 $209,565 ======== ======== ======== ======== ========
F-63 127 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
MBR TECHNOLOGIES FOR THE QUEST PERIOD FOGLIGHT COMBINED SOFTWARE JANUARY 1, SOFTWARE TOTAL PRO FORMA YEAR ENDED 1999 TO YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 17, DECEMBER 31, DECEMBER 31, PRO FORMA DECEMBER 31, 1999 1999 1999 1999 ADJUSTMENTS 1999 ------------ ------------ ------------ ------------ ----------- ------------ Revenues: Licenses............... $54,269 $ 380 $ 2,433 $57,082 $ -- $ 57,082 Services............... 16,599 190 383 17,172 -- 17,172 ------- ----- ------- ------- -------- -------- Total revenues.... 70,868 570 2,816 74,254 -- 74,254 Cost of Revenues: Licenses............... 2,998 346 109 3,453 2,550(4) 6,003 Services............... 4,195 195 207 4,597 -- 4,597 ------- ----- ------- ------- -------- -------- Total cost of revenues....... 7,193 541 316 8,050 2,550 10,600 ------- ----- ------- ------- -------- -------- Gross profit............. 63,675 29 2,500 66,204 (2,550) 63,654 Operating expenses: Sales and marketing.... 32,078 149 3,734 35,961 -- 35,961 Research and development......... 15,980 209 3,680 19,869 -- 19,869 General and administrative...... 9,906 524 1,233 11,663 -- 11,663 Other compensation costs and goodwill amortization........ 1,243 -- 409 1,652 22,826(4) 24,478 ------- ----- ------- ------- -------- -------- Total operating expenses....... 59,207 882 9,056 69,145 22,826 91,971 ------- ----- ------- ------- -------- -------- Income (loss) from operations............. 4,468 (853) (6,556) (2,941) (25,376) (28,317) Other income (expense), net.................... 1,202 (31) (865) 306 (87)(5) 219 ------- ----- ------- ------- -------- -------- Income (loss) before income tax provision... 5,670 (884) (7,421) (2,635) (25,463) (28,098) Income tax provision (benefit).............. 2,273 1 1 2,275 (3,810)(6) (1,535) ------- ----- ------- ------- -------- -------- Net income (loss)........ 3,397 (885) (7,422) (4,910) (21,653) (26,563) Preferred stock dividends, value of beneficial conversion feature, and accretion on preferred stock..... 590 -- 679 1,269 -- 1,269 ------- ----- ------- ------- -------- -------- Net income (loss) applicable to common shareholders........... $ 2,807 $(885) $(8,101) $(6,179) $(21,653) $(27,832) ======= ===== ======= ======= ======== ======== Basic and diluted net income (loss) per share.................. $ 0.07 $ (0.71) ======= ======== Weighted average shares: Basic.................. 37,677 1,278(7) 38,955 Diluted................ 41,800 (2,845)(7) 38,955
F-64 128 NOTES TO PRO FORMA FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE INFORMATION) (1) To reflect the elimination of Foglight's equity accounts and the allocation of the purchase price of $110,871 as follows: Goodwill.................................................... $101,917 Deferred tax asset, net..................................... 3,094 Purchased technology........................................ 5,100 Workforce................................................... 760
The allocation may change once the audit of Foglight's closing balance sheet is completed and other valuation information is received. (2) To reflect the conversion of all outstanding shares of preferred stock to common stock and exercise and conversion of Series C preferred stock warrants prior to the close of the Foglight acquisition. (3) To eliminate the note payable to Quest of $1,308, the forgiveness of the Cap Tech note payable and accrued interest of $1,782, and the conversion of the Convertible Subordinated Promissory Notes of $764. (4) To reflect the amortization of goodwill over five years on a straight-line basis, and workforce over three and one-half years on a straight-line basis ($20,601) and the amortization of purchased technology over two years on a straight-line basis ($2,550)for the Foglight transaction. Also includes the amortization of goodwill related to the MBR purchase for the period January 1, 1999 to December 17, 1999 of $2,225. (5) To reflect the decrease in interest income due to the use of cash in the acquisitions at a 5% annual yield. (6) To reflect the establishment of a deferred tax asset anticipated from the utilization of the operating loss of Foglight for the year and to adjust the income tax provision to reflect the estimated income tax benefit on a combined basis. (7) To adjust for the 1,187,603 and 89,630 of the 93,471 shares of Quest common stock issued in the acquisitions of Foglight and MBR, respectively, in the basic net income per share calculation and reduce the number of weighted average shares for the diluted net loss per share calculation. F-65 129 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. 130 [QUEST SOFTWARE LOGO] 131 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........................................ $ 150,464 NASD Filing Fee............................................. 25,760 Nasdaq National Market Listing Fee.......................... 0 Printing and Engraving Expenses............................. 358,672 Legal Fees and Expenses..................................... 150,000 Accounting Fees and Expenses................................ 250,000 Blue Sky Fees and Expenses.................................. 2,500 Transfer Agent Fees......................................... 10,000 Directors' & Officers' Liability Insurance.................. 0 Miscellaneous............................................... 52,604 ---------- Total............................................. $1,000,000 ==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Registrant's Amended and Restated Articles of Incorporation limit the personal liability of its directors for monetary damages to the fullest extent permitted by the California General Corporation Law (the "California Law"). Under the California Law, a director's liability to a company or its shareholders may not be limited (1) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (2) for acts or omissions that a director believes to be contrary to the best interest of the Registrant or its shareholders or that involve the absence of good faith on the part of the director, (3) for any transaction from which a director derived an improper personal benefit, (4) for acts or omissions that show a reckless disregard for the director's duty to the Registrant or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Registrant or its shareholders, (5) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Registrant or its shareholders, (6) under Section 310 of the California Law concerning contacts or transactions between the Registrant and a director, or (7) under Section 316 of the California Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to the Registrant's shareholders for any violation by a director of the director's fiduciary duty to the Registrant or its shareholders. The Registrant's Articles of Incorporation also include an authorization for the Registrant to indemnify its "agents" (as defined in Section 317 of the California Law), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Registrant's Bylaws provide for indemnification of the Registrant's directors, officers and employees. In addition, the Registrant, at its discretion, may provide indemnification to persons whom the Registrant is not obligated to indemnify. The Bylaws also allow the Registrant to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Registrant's Bylaws and Articles of Incorporation, may require the Registrant, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on II-1 132 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-2 133 8. Since June, 1998, the Registrant has granted stock options to purchase common stock under individual stock option agreements and the 1998 Stock Option/Stock Issuance Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 9. Since June, 1999, the Registrant has granted stock options to purchase common stock under the 1999 Stock Incentive Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 10. In December 1999, the Registrant issued an aggregate of 93,471 shares of its common stock to the former shareholders of MBR Technologies, Inc. in connection with the Registrant's acquisition of MBR Technologies, Inc. 11. In January 2000, the Registrant issued an aggregate of 1,187,603 shares of its common stock to the former shareholders of Foglight Software, Inc. in connection with the Registrant's acquisition of Foglight Software, Inc. None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, or any public offering, and the Registrant believes that each transaction was exempt from the registration requirements of the Securities Act by virtue of Sections 3(a)(10) or 4(2) thereof, Regulation D promulgated thereunder or Rule 701 pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701. The recipients in such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the share certificates and instruments issued in such transactions. All recipients had adequate access, through their relationships with the Registrant, to information about the Registrant. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) EXHIBITS
EXHIBIT NUMBER EXHIBIT TITLE - ------- ------------- 1.1 Form of Underwriting Agreement. 2.1 *** Agreement and Plan of Merger dated as of November 2, 1999, as amended, by and among Quest, Quest Merger Corporation, MBR Technologies, Inc., and certain shareholders of MBR Technologies, Inc. 2.2 **** Agreement and Plan of Merger dated as of November 10, 1999, by and among Quest, Quest Acquisition Corporation II, Inc., and Foglight Software, Inc. 3.1 ** Second Amended and Restated Articles of Incorporation. 3.2 ***** Second Amended and Restated Bylaws, as amended. 4.1 ** Form of Registrant's Specimen Common Stock Certificate. 5.1 Opinion of Brobeck, Phleger & Harrison LLP. 10.1 ** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2 ** Registrant's 1999 Stock Incentive Plan. 10.3 ** Registrant's 1999 Employee Stock Purchase Plan. 10.4 ** Form of Directors' and Officers' Indemnification Agreement. 10.5 ** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6 ** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC.
II-3 134
EXHIBIT NUMBER EXHIBIT TITLE - ------- ------------- 10.7 +** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8 +** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9 ** Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 10.10 ***** Office Lease between The Northwestern Mutual Life Insurance Company (Landlord) and Quest Software, Inc. (Tenant) dated as of September 30, 1999. 10.11 ++ Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software, Inc. 21.1 ***** Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Swenson Advisors LLP. 23.3 Consent of PricewaterhouseCoopers LLP. 23.4 Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 ***** Power of Attorney (Included on signature page hereto). 27.1 ***** Financial Data Schedule (In EDGAR format only).
- ------------------------- ** Incorporated by reference herein to the Registration Statement of Form S-1 and all amendments thereto filed with the Securities and Exchange Commission on June 11, 1999 and declared effective August 12, 1999. *** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on December 29, 1999. **** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on January 21, 2000. ***** Previously filed. + Confidential treatment requested and received as to certain portions of this agreement. ++ 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-4 135 (b) FINANCIAL STATEMENT SCHEDULE SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNT
BALANCE AT CHARGES, BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- --------- ---------- ---------- Year ended December 31, 1997: Allowance for doubtful accounts and sales returns......................................... $ 546 $ 584 $ (347) $ 783 Year ended December 31, 1998: Allowance for doubtful accounts and sales returns......................................... $ 783 $1,116 $ (847) $1,052 Year ended December 31, 1999: Allowance for doubtful accounts and sales returns......................................... $1,052 $5,451 $(3,264) $3,239
ITEM 17. UNDERTAKINGS The Registrant hereby undertakes to provide to the underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the California General Corporation Law, the Amended and Restated Articles of Incorporation or the Amended and Restated Bylaws of the Registrant, Indemnification Agreements entered into between the Registrant and its officers and directors, the Underwriting Agreement, or otherwise, the Registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective; (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 136 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Amendment No. 2 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on this 3rd day of March, 2000. 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 March 3, 2000 - --------------------------------------------------- (principal executive officer) Vincent C. Smith and Chairman of the Board /s/ DAVID M. DOYLE President, Secretary and Director March 3, 2000 - --------------------------------------------------- David M. Doyle * Chief Financial Officer March 3, 2000 - --------------------------------------------------- (principal financial and John J. Laskey accounting officer) and Vice President, Finance * Director March 3, 2000 - --------------------------------------------------- Doran G. Machin * Director March 3, 2000 - --------------------------------------------------- Jerry Murdock, Jr. *By: /s/ DAVID M. DOYLE --------------------------------------------- David M. Doyle (Attorney-in-fact)
II-6 137 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT TITLE - ------- ------------- 1.1 Form of Underwriting Agreement. 2.1 *** Agreement and Plan of Merger dated as of November 2, 1999, as amended, by and among Quest, Quest Merger Corporation, MBR Technologies, Inc., and certain shareholders of MBR Technologies, Inc. 2.2 **** Agreement and Plan of Merger dated as of November 10, 1999, by and among Quest, Quest Acquisition Corporation II, Inc., and Foglight Software, Inc. 3.1 ** Second Amended and Restated Articles of Incorporation. 3.2 ***** Second Amended and Restated Bylaws, as amended. 4.1 ** Form of Registrant's Specimen Common Stock Certificate. 5.1 Opinion of Brobeck, Phleger & Harrison LLP. 10.1 ** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2 ** Registrant's 1999 Stock Incentive Plan. 10.3 ** Registrant's 1999 Employee Stock Purchase Plan. 10.4 ** Form of Directors' and Officers' Indemnification Agreement. 10.5 ** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6 ** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.7 +** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8 +** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9 ** Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 10.10 ***** Office Lease between The Northwestern Mutual Life Insurance Company (Landlord) and Quest Software, Inc. (Tenant) dated as of September 30, 1999. 10.11 ++ Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software, Inc. 21.1 ***** Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Swenson Advisors LLP. 23.3 Consent of PricewaterhouseCoopers LLP. 23.4 Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 ***** Power of Attorney (Included on signature page hereto). 27.1 ***** Financial Data Schedule (In EDGAR format only).
- ------------------------- ** Incorporated by reference herein to the Registration Statement of Form S-1 and all amendments thereto filed with the Securities and Exchange Commission on June 11, 1999 and declared effective August 12, 1999. *** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on December 29, 1999. **** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on January 21, 2000. ***** Previously filed. + Confidential treatment requested and received as to certain portions of this agreement. ++ 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 Draft of March 1, 2000 UNDERWRITING AGREEMENT March __, 2000 Fleet Boston Robertson Stephens Inc. Chase Securities Inc. Donaldson, Lufkin & Jenrette Securities Corporation CIBC World Markets Corp. SoundView Technology Group, Inc. First Albany Corporation As Representatives of the Several Underwriters c/o FleetBoston Robertson Stephens Inc. 555 California Street, Suite 2600 San Francisco, California 94104 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 1,000,000 shares of its Common Stock, no par value (the "Common Shares"); and the shareholders of the Company named in Schedule B (the "Selling Shareholders") severally propose to sell to the Underwriters an aggregate of 1,800,000 Common Shares. The 1,000,000 Common Shares to be sold by the Company and the 1,800,000 shares of Common Shares to be sold by the Selling Shareholders are collectively called the "Firm Shares". In addition, the Company has granted to the Underwriters an option to purchase up to an additional 420,000 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". FleetBoston Robertson Stephens Inc. ("FleetBoston Robertson Stephens") and Chase Securities Inc., Donaldson, Lufkin & Jenrette Securities Corporation, CIBC World Markets Corp., SoundView Technology Group, Inc. and 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 Common Shares. As a part of this offering contemplated by this Agreement The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-1 (File No. 333-30816), which contains a form of prospectus, subject to completion, to be used in connection with the 2 public offering and sale of the Shares. Each such prospectus, subject to completion, used in connection with such public offering is called a "preliminary prospectus". 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 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 of the Shares, is called the "Prospectus". All references in this Agreement to the Registration Statement, the Rule 462(b) Registration Statement, a preliminary prospectus, the Prospectus 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 and each of the Selling Shareholders hereby confirm their respective agreements with the Underwriters as follows: SECTION 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. 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. Each preliminary prospectus, as of its date, and the Prospectus, as amended or supplemented, as of its date and at all subsequent times through the 30th day of the date hereof, 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 2 3 the Representatives expressly for use therein. There are no contracts or other documents required to be 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 six 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. Authorization of the Shares To Be Sold by the Selling Shareholders. The Common Shares to be purchased by the Underwriters from the Selling Shareholders, when issued, were, or, in the case of optionees, will be validly issued, fully paid and nonassessable. (g) 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, other than the Selling Shareholders with respect to the Shares included in the Registration Statement, except for such rights as have been duly waived or are inapplicable. (h) 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 other subsidiaries, any of its subsidiaries on any class of 3 4 capital stock or repurchase or redemption by the Company or any of its subsidiaries of any class of capital stock. (i) 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 and the Securities and Exchange Act of 1934 (the "Exchange Act"). (j) 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 as applied in the United States 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 "Summary--Consolidated Selected Financial Data", "Consolidated 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. The unaudited pro forma information of the Company and the related notes thereto included in the Prospectus and in the Registration Statement present fairly the information contained therein, have been prepared in accordance with the Commission's rules and guidelines with respect to pro forma financial statements an have been properly presented on the bases described therein, and the assumptions used in the preparation thereof are reasonable and the adjustments used therein are appropriate to give effect to the transactions and circumstances referred to therein. No other pro forma financial information is required to be included in the Registration Statement Pursuant to Regulation S-X. (k) 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 as applied in the United States 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 material differences. (l) 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 to the Registration Statement. (m) 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. 4 5 (n) 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. (o) 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. (p) 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. (q) Stock Exchange Listing. The Shares are registered pursuant to Section 12(b) of this Securities Exchange Act of 1934 (the "Exchange Act") and are listed on the Nasdaq National Market, and the Company has taken no action designed to, or likely to have the effect of, terminating the registration of the Common Shares under the Exchange Act or delisting the Common Shares from the Nasdaq National Market, nor has the Company received any notification that the Commission or the National Association of Securities Dealers, LLC (the "NASD") is contemplating terminating such registration or listing. (r) 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. (s) 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 5 6 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, 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. (t) 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. (u) 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. (v) 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. (w) 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(A)(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. (x) Tax Law Compliance. The Company and its 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, other than those being contested in good faith. The 6 7 Company has made adequate charges, accruals and reserves in the applicable financial statements referred to in Section 1(A)(i) above in respect of all federal, state and foreign income and franchise taxes for all periods as to which the tax liability of the Company or any of its 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. (y) 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 reasonably 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. The Company has not received any written notice of any 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. (z) Y2K. There are no Y2K issues related to the Company, or any of its subsidiaries, that (i) are of a character required to be described or referred to in the Registration Statement or Prospectus by the Securities Act or by the Exchange Act or the rules and regulations of the Commission thereunder 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. (aa) 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. (bb) 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. (cc) 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 7 8 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. (dd) Labor Matters. To the best of the 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 that might be expected to result in a Material Adverse Change. (ee) 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. (ff) Lock-Up Agreements. Each officer and director of the company, each Selling Shareholder and each beneficial owner of one or more percent of the outstanding issued share 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 shareholders from any Lock-up Agreements currently existing or hereafter effected without the prior written consent of Robertson Stephens. (gg) 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. B. Representations and Warranties of the Selling Shareholders. Each Selling Shareholder represents, warrants and covenants to each Underwriter as follows: (a) The Underwriting Agreement. This Agreement has been duly authorized, executed and delivered by or on behalf of such Selling Shareholder and is a valid and binding agreement of such Selling Shareholder, 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. 8 9 (b) The Custody Agreement and Power of Attorney. Each of the (i) Custody Agreement and Power of Attorney signed by such Selling Shareholder and U.S. Stock Transfer Corporation, as custodian (the "Custodian"), relating to the deposit of the Shares to be sold by such Selling Shareholder and appointing certain individuals named therein as such Selling Shareholder's attorneys-in-fact (each an "Attorney-in Fact"), (the "Custody Agreement") has been duly authorized, executed and delivered by such Selling Shareholder and is a valid and binding agreement of such Selling Shareholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof 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. Each Selling Shareholder agrees that the Shares to be sold by such Selling Shareholder on deposit with the Custodian is subject to the interests of the Underwriters, that the arrangements made for such custody are to that extent irrevocable, and that the obligations of such Selling Shareholder hereunder shall not be terminated, except as provided in this Agreement or in the Custody Agreement, by any act of the Selling Shareholder, by operation of law, by death or incapacity of such Selling Shareholder or by the occurrence of any other event. If such Selling Shareholder should die or become incapacitated, or in any other event should occur, before the delivery of the Shares to be sold by such Selling Shareholder hereunder, the documents evidencing the Shares to be sold by such Selling Shareholder then on deposit with the Custodian shall be delivered by the Custodian in accordance with the terms and conditions of this Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Custodian shall have received notice thereof. (c) Title to Shares to be Sold. Such Selling Shareholder is the lawful owner of the Shares to be sold by such Selling Shareholder hereunder and upon sale and delivery of, and payment for, such Shares, as provided herein, such Selling Shareholder will convey good and marketable title to such Shares, free and clear of all liens, encumbrances, equities and claims whatsoever. (d) All Authorizations Obtained. Such Selling Shareholder has, and on the First Closing Date and the Second Closing Date will have, good and valid title to all of the Company Shares which may be sold by such Selling Shareholder pursuant to this Agreement on such date and the legal right and power, and all authorizations and approvals required by law and under its charter or by-laws,partnership agreement, trust agreement or other organizational documents, as appropriate, to enter into this Agreement and its Custody Agreement and Power of Attorney, to sell, transfer and deliver all of the Shares which may be sold by such Selling Shareholder pursuant to this Agreement and to comply with its other obligations hereunder and thereunder. (e) No Further Consents, Authorization or Approvals. No consent, approval, authorization or order of any court or governmental agency or body is required for the consummation by such Selling Shareholder of the transactions contemplated herein, except such as may have been obtained under the Securities Act and such as may be required under the federal and provincial securities laws of Canada or the blue sky laws or any jurisdiction in connection with the purchase and distribution of the Shares by the Underwriters and such other approvals as have been obtained. (f) Non-Contravention. Neither the sale of the Securities being sold by such Selling Shareholder nor the consummation of any other of the transactions herein contemplated by such Selling Shareholder or the fulfillment of the terms hereof by such Selling Shareholder will conflict with, result in a breach or violation of, or constitute a default under any law or the terms 9 10 of any indenture or other agreement or instrument to which such Selling Shareholder is party or bound, any judgment, order or decree applicable to such Selling Shareholder or any court or regulatory body, administrative agency, governmental body or arbitrator having jurisdiction over such Selling Shareholder. (g) No Registration or Other Similar Rights. Such Selling Shareholder does not have any registration or other similar rights to have any equity or debt securities registered for sale by the Company under the Registration Statement or included in the offering contemplated by this Agreement, except for such rights as are described in the Prospectus under "Description of Capital Stock". (h) No Preemptive, Co-sale or other Rights. Such Selling Shareholder does not have, or has waived prior to the date hereof, any preemptive right, co-sale right or right of first refusal or other similar right to purchase any of the Shares that are to be sold by the Company or any of the other Selling Shareholders to the Underwriters pursuant to this Agreement; and such Selling Shareholder does not own any warrants, options or similar rights to acquire, and does not have any right or arrangement to acquire, any capital stock, right, warrants, options or other securities from the Company, other than those described in the Registration Statement and the Prospectus. (i) Disclosure Made by Such Selling Shareholder in the Prospectus. All information furnished by or on behalf of such Selling Shareholder in writing expressly for use in the Registration Statement and Prospectus is, and on the First Closing Date and the Second Closing Date will be, true, correct, and complete in all material respects, and does not, and on the First Closing Date and the Second Closing Date will not, contain any untrue statement of a material fact or omit to state any material fact necessary to make such information not misleading. Such Selling Shareholder confirms as accurate the number of shares of Company Shares set forth opposite such Selling Shareholder's name in the Prospectus under the caption "Principal and Selling Shareholders" (both prior to and after giving effect to the sale of the Shares). (j) No Price Stabilization or Manipulation. Such Selling Shareholder 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. (k) No Transfer Taxes or Other Fees. To such Selling Stockholder's knowledge, here 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 sale by the Selling Shareholders of the Shares. (l) Distribution of Offering Materials by the Selling Shareholders. The Selling Shareholders have 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 by such Selling Shareholder other than a preliminary prospectus, the Prospectus or the Registration Statement. (m) Confirmation of Company Representations and Warranties. Such Selling Shareholder has no reason to believe that the representations and warranties of the Company contained in Section 1(A) hereof are not true and correct, is familiar with the Registration Statement and the Prospectus and has no knowledge of any material fact, condition or 10 11 information not disclosed in the Registration Statement or the Prospectus which has had or may result in a Material Adverse Change on the condition, financial or otherwise, or on the earnings, business, operation or prospects, whether or not arising from transactions in the ordinary course of business of the Company and its subsidiaries, considered as one entity, and is not prompted to sell the Shares to be sold by such Selling Shareholder by any information concerning the Company which is not set forth in the Registration Statement and the Prospectus. Any certificate signed by or on behalf of any Selling Shareholder and delivered to the Representatives or to counsel for the Underwriters shall be deemed to be a representation and warranty by such Selling Shareholder to each Underwriter as to the matters covered thereby. SECTION 2. PURCHASE, SALE AND DELIVERY OF THE SHARES. (a) The Firm Shares. Upon the terms herein set forth, (i) the Company agrees to issue and sell to the several Underwriters an aggregate of 1,000,000 Firm Shares and (ii) the Selling Shareholders agree to sell to the several Underwriters an aggregate of 1,800,000 Firm Shares, each Selling Shareholder selling the number of Firm Shares set forth opposite such Selling Shareholder's name on Schedule B1 and Schedule B2. 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 and the Selling Shareholders 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 and the Selling Shareholders 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 the time and place required by Section 2(f) below, 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 2(g) and 3(e) hereof, the Representatives may, in their sole discretion, postpone the Closing Date until no later than 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 purchase, severally and not jointly, up to an aggregate of 420,000 Option Shares from the Company and/or the Selling Shareholders 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, 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 11 12 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 and the Selling Shareholders 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, have determined is advisable and practicable. (e) Payment for the Shares. Payment for the Shares to be sold by the Company shall be made at the First Closing Date (and, if applicable, at the Second Closing Date) by wire transfer of immediately available funds to the order of the Company. Payment for the Shares to be sold by the Selling Shareholders shall be made at the First Closing Date (and, if applicable, at the Second Closing Date) by wire transfer of immediately available funds to the order of the Custodian. It is understood that the Representatives have been authorized, for their 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. Each Selling Shareholder hereby agrees that (i) it will pay all stock transfer taxes, stamp duties and other similar taxes, if any, payable upon the sale or delivery of the Shares to be sold by such Selling Shareholder to the several Underwriters, or otherwise in connection with the performance of such Selling Shareholder's obligations hereunder and (ii) the Custodian is authorized to deduct for such payment any such amounts from the proceeds to such Selling Shareholder hereunder and to hold such amounts for the account of such Selling Shareholder with the Custodian under the Custody Agreement. (f) Delivery of the Shares. The Company and the Selling Shareholders 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 and the Selling Shareholders shall also deliver, or cause to be delivered a credit representing the Option 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 or the Second Closing Date, as the case may be, 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. (g) 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 12 13 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 AND THE SELLING SHAREHOLDERS. A. 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 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 (ii) 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 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 13 14 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 reasonably request. (f) Insurance. The Company shall maintain its Directors and Officers liability insurance in the minimum amount of $10 million which shall apply to 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. (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 March 31, 20001 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 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 14 15 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 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. These restrictions terminate after the close of trading of the Shares on the 90th day of (and including) the day the Shares commenced trading on the Nasdaq National Market (the "Lock-Up Period"). (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, shareholders' 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. (n) Exchange Act Compliance. During the Prospectus Delivery Period, the Company will file all documents required to be filed with the Commission pursuant to Section 13, 14 or 15 of the Exchange Act in the manner and within the time periods required by the Exchange Act. B. COVENANTS OF THE SELLING SHAREHOLDERS. Each Selling Shareholder further covenants and agrees with each Underwriter: (a) Agreement Not to Offer or Sell Additional Securities. Such Selling Shareholder will not, during the Lock-Up Period, make a disposition of Securities (as defined in Exhibit A hereto) 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 Shares acquired on the open market or (iv) with the prior written consent of BancBoston Robertson Stephens Inc. 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 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 includes, relates to or derives any significant part of its value from Securities. Furthermore, such person has also agreed and consented to the entry of stop transfer instructions with the Company's transfer 15 16 agent against the transfer of the Securities held by such person except in compliance with this restriction. (b) Delivery of Forms W-8 and W-9. To deliver to the Representatives prior to the First Closing Date a properly completed and executed United States Treasury Department Form W-8 (if the Selling Shareholder is a non-United States person) or Form W-9 (if the Selling Shareholder is a United States Person). (c) Notification of Untrue Statements, etc. If, at any time prior to the date on which the distribution of the Common Shares as contemplated herein and in the Prospectus has been completed, as determined by the Representatives, such Selling Shareholder has knowledge of the occurrence of any event as a result of which the Prospectus or the Registration Statement, in each case as then amended or supplemented, would include an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, such Selling Shareholder will promptly notify the Company and the Representatives. 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 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 and the Selling Shareholders set forth in Sections 1(A) and 1(B) 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 and the Selling Shareholders of their respective 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, any Selling Shareholder 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 counsel for the Underwriters; 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 or Ratings Agency 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, 16 17 (i) 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; and (ii) there shall not have occurred any downgrading, nor shall any notice have been given of any intended or potential downgrading or of any review for a possible change that does not indicate the direction of the possible change, in the rating accorded any of the Company's securities by any "nationally recognized statistical rating organization," as such term is defined for purposes of Rule 436(g)(2) under the Act. (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, the Selling Shareholders or officers of the Selling Shareholders (when the Selling Shareholder is not a natural person), 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 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. (e) Opinion of U.K. 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 Hale & Dorr International, special U.K. counsel for the Company, substantially in the form of Exhibit C 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. (f) 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, substantially in the form of Exhibit D 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. (g) 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 17 18 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 reasonably 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, 1999 and related consolidated statements of operations, shareholders' equity, and cash flows for the twelve (12) months ended December 31,1999, 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 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, 1999, did not disclose any weaknesses in internal controls that they considered to be material weaknesses. (h) 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 or the Exchange Act and the applicable rules and regulations of the Commission thereunder, as the case may be, 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, as the case may be, 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 18 19 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 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. (i) Lock-up Agreement from Certain Shareholders 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, each Selling Shareholder and each beneficial owner of one or more percent of the outstanding issued share capital of the Company. (j) Opinion of Counsel for the Selling Shareholders]. You shall have received on the First Closing Date and the Second Closing Date, as the case may be, an opinion of [NAME OF SELLING SHAREHOLDERS' COUNSEL], counsel for the Selling Shareholders substantially in the form of Exhibit E hereto. In rendering such opinion, such counsel may rely as to questions of law not involving the laws of the United States or State of [SELLING SHAREHOLDER'S STATE] and [STATE OF COMPANY'S INCORPORATION] upon opinions of local counsel and as to questions of fact upon representations or certificates of the Selling Shareholders or officers of the Selling Shareholders (when the Selling Shareholder is not a natural person), and of governmental 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 of any material misstatement or inaccuracy in any such opinion, representation or certificate so relied upon shall be delivered to you, as Representatives of the Underwriters, and to Underwriters' Counsel. (k) Selling Shareholders' Certificate. On each of the First Closing Date and the Second Closing Date, as the case may be, the Representatives shall received a written certificate executed by the Attorney-in-Fact of each Selling Shareholder, dated as of such Closing Date, to the effect that: (i) the representations, warranties and covenants of such Selling Shareholder set forth in Section 1(B) of this Agreement are true and correct with the same force and effect as though expressly made by such Selling Shareholder on and as of such Closing Date; and 19 20 (ii) such Selling Shareholder has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date. (l) Selling Shareholders' Documents. At least three business days prior to the date hereof, the Company and the Selling Shareholders shall have furnished for review by the Representatives copies of the Powers of Attorney and Custody Agreements executed by each of the Selling Shareholders and such further information, certificates and documents as the Representatives may reasonably request. (m) 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. (n) 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 and the Selling Shareholders 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 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, (viii) 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 20 21 and distribution of the Common Shares, (ix) the fees and expenses associated with including the Common Shares on the Nasdaq National Market, (x) all costs and expenses incident to the travel and accommodation of the Company's employees on the "roadshow", and (xi) 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. The Selling Shareholders further agree with each Underwriter to pay (directly or by reimbursement) all fees and expenses incident to the performance of their obligations under this Agreement which are not otherwise specifically provided for herein, including but not limited to (i) fees and expenses of counsel and other advisors for such Selling Shareholders unless the Company is otherwise obligated to pay such fees, (ii) fees and expenses of the Custodian and (iii) expenses and taxes incident to the sale and delivery of the Common Shares to be sold by such Selling Shareholders to the Underwriters hereunder (which taxes, if any, may be deducted by the Custodian under the provisions of Section 2 of this Agreement). This Section 5 shall not affect or modify any separate, valid agreement relating to the allocation of payment of expenses between the Company, on the one hand, and the Selling Shareholders, on the other hand. Section 6. REIMBURSEMENT OF UNDERWRITERS' EXPENSES. If this Agreement is terminated by the Representatives pursuant to Section 4, Section 8, Section 9 or Section 15, 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 or the Selling Shareholders 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 and accommodation expenses, postage, facsimile and telephone charges. 21 22 SECTION 7. INDEMNIFICATION AND CONTRIBUTION. (a) Indemnification of the Underwriters. (1) 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 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 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; or (iv) in whole or in part upon any failure of the Company or the Principal Selling Shareholders to perform its obligations hereunder or under law; or (v) any untrue statement or alleged untrue statement of any material fact contained in any audio or visual materials provided by the Company or based upon written information furnished by or on behalf of the Company including, without limitation, slides, videos, films or tape recordings, used in connection with the marketing of the Shares, including without limitation, statements communicated to securities analysts employed by the Underwriters; or (vi) 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), (iv) or (v) above, provided that the Company shall not be liable under this clause (vi) 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 Fleet Boston Robertson Stephens) 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 22 23 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, 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 and the Selling Shareholders may otherwise have. (2) Each of the Selling Shareholders, jointly and severally, 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 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 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, in the case of subparagraphs (i) and (ii) of this Section 7(a)(2) to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company or such Underwriter by such Selling Shareholder directly or through such Selling Shareholder's representatives, specifically for use in the preparation thereof; or (iii) in whole or in part upon any inaccuracy in the representations and warranties of the Selling Shareholders contained herein; or (iv) in whole or in part upon any failure of the Selling Shareholders to perform their respective 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 Selling Shareholders 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 Robertson Stephens) 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 Selling Shareholders by the Representatives expressly for use in the Registration Statement, any preliminary prospectus 23 24 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 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 Selling Shareholders may otherwise have; and provided, further, that the liability of each Selling Shareholder under the foregoing indemnity agreement shall be limited to an amount equal to the initial public offering price of the Shares sold by such Selling Shareholder, less the underwriting discount, as set forth on the front cover page of the Prospectus. (b) Indemnification of the Company, its Directors, Officers and Selling Shareholders. 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, the Selling Shareholders and each person, if any, who controls the Company or any Selling Shareholder 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, Selling Shareholder 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 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 and the Selling Shareholders by the Representatives expressly for use therein; and to reimburse the Company, or any such director, officer, Selling Shareholder or controlling person for any legal and other expense reasonably incurred by the Company, or any such director, officer, Selling Shareholder 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 and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act, 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 paragraph and the second paragraph third and ninth paragraphs under the caption "Underwriting" in the Prospectus; and the Underwriters confirm that such statements are correct. 24 25 (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 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 (Robertson Stephens 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 60 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 25 26 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 such party 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 such party 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 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 and the Selling Shareholders 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 each Selling Shareholder 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 forty-five (45) days of invoice to the indemnifying party. (h) Survival. The indemnity and contribution agreements contained in this Section 7 and the representation and warranties 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 26 27 (iii) any termination of this Agreement. A successor to any Underwriter, or to the Company, its directors or officers, any Selling Shareholder 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 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 5, 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. This Agreement may be terminated by the Representatives by notice given to the Company and the Selling Shareholders if (a) at any time after the execution and delivery of this Agreement and prior to the First Closing Date (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; 27 28 (ii) a general banking moratorium shall have been declared by any of federal, New York, Delaware 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 contemplated in the Prospectus or to enforce contracts for the sale of securities; (iv) in the 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 or (b) in the case of any of the events specified 9(a)(i)-(v), such event singly or together with any other event, makes it, in your judgement, impracticable or inadvisable to market the Common Shares in the manner and on the terms contemplated in the Prospectus. Any termination pursuant to this Section 9 shall be without liability on the part of (x) the Company or the Selling Shareholders to any Underwriter, except that the Company and the Selling Shareholders shall be obligated to reimburse the expenses of the Representatives and the Underwriters pursuant to Sections 5 and 6 hereof, (y) any Underwriter to the Company or any person controlling the Company or the Selling Shareholders, or (z) 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 or any person controlling the company, of its officers, of the Selling Shareholders 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, or the Selling Shareholders, 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: FLEETBOSTON ROBERTSON STEPHENS INC. 555 California Street San Francisco, California 94104 Facsimile: (415) 676-2675 Attention: General Counsel If to the Company: Quest Software, Inc. 8001 Irvine Center Drive Facsimile: 949-754-0426 Attention: Mr. Vincent C. Smith If to the Selling Shareholders: 28 29 U.S. Stock Transfer Corporation [address] Facsimile: [___] Attention: [___] 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 8 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 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. 29 30 Section 15. FAILURE OF ONE OR MORE OF THE SELLING SHAREHOLDERS TO SELL AND DELIVER COMMON SHARES. If one or more of the Selling Shareholders shall fail to sell and deliver to the Underwriters the Shares to be sold and delivered by such Selling Shareholders at the First Closing Date pursuant to this Agreement, then the Underwriters may at their option, by written notice from the Representatives to the Company and the Selling Shareholders, either (i) terminate this Agreement without any liability on the part of any Underwriter or, except as provided in Sections 5, 6, and 7 hereof, the Company or the Selling Shareholders, or (ii) purchase the shares which the Company and other Selling Shareholders have agreed to sell and deliver in accordance with the terms hereof. If one or more of the Selling Shareholders shall fail to sell and deliver to the Underwriters the Shares to be sold and delivered by such Selling Shareholders pursuant to this Agreement at the First Closing Date or the Second Closing Date, then the Underwriters shall have the right, by written notice from the Representatives to the Company and the Selling Shareholders, 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. Section 16. 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. Section headings herein are for the convenience of the parties only and shall not affect the construction or interpretation of this Agreement. [The remainder of this page has been intentionally left blank.] 30 31 If the foregoing is in accordance with your understanding of our agreement, please sign and return to the Company and the Custodian 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: -------------------------------------- [Title] SELLING SHAREHOLDERS By: -------------------------------------- Attorney-in-fact for the Selling Shareholders named in Schedule The foregoing Underwriting Agreement is hereby confirmed and accepted by the Representatives as of the date first above written. FLEETBOSTON ROBERTSON STEPHENS INC. CHASE SECURITIES INC. DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION SOUNDVIEW TECHNOLOGY GROUP, INC. 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 FLEETBOSTON ROBERTSON STEPHENS INC. By: ---------------------------------- Mitch Whiteford 31 32 SCHEDULE A
NUMBER OF FIRM COMMON SHARES TO UNDERWRITERS BE PURCHASED - ------------------------------------------------------------ ------------------------------- FLEETBOSTON ROBERTSON STEPHENS INC.......................... [___] Chase Securities Inc. ...................................... [___] Donaldson, Lufkin & Jenrette Securities Corporation......... [___] SoundView Technology Group, Inc. ........................... [___] CIBC World Markets Corp..................................... [___] First Albany Corporation.................................... [___] Total............................................... [___]
S-A 33 SCHEDULE B
MAXIMUM NUMBER OF NUMBER OF FIRM OPTION SHARES SELLING SHAREHOLDER SHARES TO BE SOLD TO BE SOLD ------------------- ----------------- ----------------- ================= =================
S-B 34 EXHIBIT A LOCK-UP AGREEMENT Fleet Boston Robertson Stephens Inc. Chase Securities Inc. Donaldson, Lufkin & Jenrette Securities Corporation SoundView Technology Group, Inc. CIBC World Markets Corp. First Albany Corporation As Representatives of the Several Underwriters c/o FleetBoston Robertson Stephens Inc. 555 California Street, Suite 2600 San Francisco, California 94104 RE: ____________________ (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 sales or purchases of Common Stock acquired on the open market or (iv) with the prior written consent of FleetBoston Robertson Stephens Inc. The foregoing restrictions will commence on the date hereof and terminate after the close of trading of the Common Stock on the 90th day of (and including) the day the Common Stock commenced trading on the Nasdaq National Market (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 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 A-1 35 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. In the event the Offering has not occurred on or before ____________, this Lock-Up Agreement shall be of no further force or effect. Dated ---------------------------------- ---------------------------------------- Printed Name of Holder By: ------------------------------------- Signature ---------------------------------------- Printed Name of Person Signing (and indicate capacity of person signing if signing as custodian, trustee, or on behalf of an entity) A-2 36 EXHIBIT B FORM OF OPINION OF COMPANY COUNSEL 1. The Company is duly incorporated and is validly existing and in good standing under the laws of the State of California; the Company has the corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Registration Statement and the Prospectus (and any amendment or supplement thereto); the Company has the status set forth opposite the jurisdictions listed on Schedule A hereto; 2. The authorized, issued and outstanding capital stock of the Company as of December 31, 1999 is as set forth under the heading "Actual" under the caption "Capitalization" in the Prospectus; to our knowledge, except as described in the Prospectus, there are no outstanding securities of the Company convertible or exchangeable into, or evidencing the right to purchase or subscribe for, any shares of capital stock of the Company and there are no outstanding or authorized options, warrants or rights of a similar character obligating the Company to issue any shares of its capital stock or any securities convertible or exchangeable into, or evidencing the right to purchase or subscribe for, any shares of such stock; 3. All the shares of capital stock of the Company outstanding prior to the issuance of the Shares (A) have been duly authorized and validly issued; (B) are fully paid and nonassessable; and (C) will not have been issued in violation of or subject to any preemptive right, or, to our knowledge, any co-sale right, registration right, right of first refusal or other similar right of which we are aware; 4. The Shares have been duly authorized and, when issued and delivered to the Underwriters against payment therefor in accordance with the terms of the Underwriting Agreement, will be validly issued, fully paid and nonassessable and free of (A) any preemptive rights arising under the Restated Articles or the California General Corporation Law, (B) similar rights that entitle or will entitle any person to acquire any shares of capital stock of the Company upon the issuance and sale of the Shares by the Company, or (C) will not have been issued in violation of or subject to any preemptive right, or, to our knowledge, any co-sale right, registration right, right of first refusal or other similar right of which we are aware; 5. The Registration Statement and all post-effective amendments, if any, have become effective under the Securities Act and, to our knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose are pending before or contemplated by the Commission; and any required filing of the Prospectus pursuant to Rule 424(b) has been made in accordance with Rule 424(b); 6. The Company has the corporate power and authority to enter into the Underwriting Agreement and to issue, sell and deliver the Shares to the Underwriters as B-1 37 provided in the Underwriting Agreement; the Underwriting Agreement has been duly authorized, executed and delivered by the Company, and (assuming the due authorization, execution and delivery thereof by you) is a valid and binding agreement of the Company, enforceable against it in accordance with its terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights and remedies generally, and subject, as to enforceability, to general principles (whether relief is sought in a proceeding at law or in equity) and except as rights to indemnification and contribution thereunder may be limited by applicable law or public policy relating thereto; 7. Neither the offer, sale or delivery of the Shares, the execution, delivery or performance by the Company of the Underwriting Agreement, compliance by the Company with the provisions of the Underwriting Agreement nor consummation by the Company of the transactions contemplated by the Underwriting Agreement (A) violates the Restated Articles or the Bylaws of the Company, or (B) constitutes a breach of, or a default under, any material provision of any agreement, indenture, lease or other instrument to which the Company is a party or by which the Company or any of its properties is bound that is an exhibit to the Registration Statement, or (C) will result in any violation of any existing law or regulation (other than applicable state securities and Blue Sky laws, as to which we express no opinion), or any ruling, judgment, injunction, order or decree known to us and applicable to the Company or any of its properties; 8. No consent, approval, authorization or other order of, or registration or filing with, any court, regulatory body, administrative agency or other governmental body, agency, or official is required on the part of the Company (except (A) as have been obtained under the Securities Act and the Exchange Act, (B) such as may be required under state securities or Blue Sky laws governing the purchase and distribution of the Shares, or (C) such as may be required by the National Association of Securities Dealers, LLC, as to which we express no opinion) for the valid issuance and sale of the Shares to the Underwriters as contemplated by the Underwriting Agreement; 9. To our knowledge, (A) there are no legal or governmental proceedings pending or threatened against the Company, or to which the Company or any of its properties is subject, which are required to be described in the Registration Statement or Prospectus (or any amendment or supplement thereto) that are not so described and (B) there are no agreements, contracts, indentures, leases or other instruments that are required to be described in the Registration Statement or the Prospectus (or any amendment or supplement thereto) or to be filed as an exhibit to the Registration Statement that are not so described or filed, as the case may be; 10. The statements set forth under the caption "Description of Capital Stock" in the Prospectus, insofar as such statements purport to summarize certain provisions of the capital stock of the Company provides a fair summary of such provisions in all material respects, and any description in the Registration Statement and Prospectus of the Restated Articles and Bylaws and any statute fairly present, in all material respects, the information required to be presented by the Securities Act and the applicable rules and regulations thereunder. 11. 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, would not be, an "investment company" as such term is defined in the Investment Company Act of 1940, as amended. B-2 38 EXHIBIT C FORM OF OPINION OF COMPANY'S U.K COUNSEL 1. The Subsidiary has been duly incorporated and is validly existing as a corporation in good standing under the laws of England and Wales. 2. The Subsidiary has the corporate power and authority to owe, lease and operate its property as described in the Prospectus. 3. The Subsidiary has the corporate power and authority to conduct its business as described in the Prospectus. 4. The Subsidiary is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction, if any, in which, to our knowledge, it owns or leases properties or otherwise conducts its business, except where the failure to be so qualified or be in good standing would not have a Material Adverse Effect. C-1 39 EXHIBIT D 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 Securities Act. (iii) The Underwriting Agreement has been duly authorized, executed and delivered by the Company. (iv) The Underwriting Agreement has been duly authorized, executed and delivered by the Selling Shareholders. Such counsel shall state that such counsel has reviewed the opinions addressed to the Representatives from [list each set of counsel that has provided an opinion], each dated the date hereof, and furnished to you in accordance with the provisions of the Underwriting Agreement. Such opinions appear on their 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. D-1 40 EXHIBIT E MATTERS TO BE COVERED IN THE OPINION OF SELLING SHAREHOLDER COUNSEL (i) The Underwriting Agreement has been duly authorized, executed and delivered by or on behalf of, and is a valid and binding agreement of, such Selling Shareholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. (ii) The execution and delivery by such Selling Shareholder of, and the performance by such Selling Shareholder of its obligations under, the Underwriting Agreement and its Custody Agreement will not contravene or, to the best of such counsel's knowledge, contravene any other agreement or instrument to which such Selling Shareholder is a party or by which it is bound, or any judgement, order or decree applicable to such Selling Shareholder of any court, administrative agency governmental body having jurisdiction over such Selling Shareholder. (iii) Such Selling Shareholder is the sole registered owner of the Common Shares which may be sold by such Selling Shareholder under the Underwriting Agreement and has the legal right and power, and authorizes to enter into the Underwriting Agreement and its Custody Agreement and to sell, transfer and deliver all of the Common Shares which may be sold by such Selling Shareholder under the Underwriting Agreement. (iv) The Custody Agreement of such Selling Shareholder has been duly authorized, executed and delivered by such Selling Shareholder and is a valid and binding agreement of such Selling Shareholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. (v) Upon delivery of and payment for the Shares as contemplated in the Underwriting Agreement, each of the Underwriters will receive valid marketable title to the Shares purchased from such the ________ Selling Shareholder free of any adverse claim, assuming __________ purchase such shares for value, in good faith ___________ any adverse claims as defined in the Uniform Commercial Code of the State of California. E-1 EX-5.1 3 OPINION OF BROBECK, PHLEGER & HARRISON LLP. 1 EXHIBIT 5.1 38 TECHNOLOGY DRIVE IRVINE TELEPHONE: (949) 790-6300 CALIFORNIA 92618-5312 FACSIMILE: (949) 790-6301 www.brobeck.com March 3, 2000 Quest Software, Inc. 8001 Irvine Center Drive Irvine, CA 92618 Re: Quest Software, Inc. Registration Statement on Form S-1 for 4,830,000 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 1,904,230 shares of the Company's Common Stock (the "Company Shares"), the sale by certain shareholders (the "Selling Shareholders") of up to 2,295,770 shares of the Company's Common Stock (the "Selling Shareholder Shares"), and the sale of up to 630,000 shares of the Company's Common Stock by the Company and/or the Selling Shareholders in the event the underwriters exercise their over-allotment option (the "Over-allotment Shares" and, together with the Company Shares and the Selling Shareholder Shares, 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 (i) the Shares have been duly authorized, (ii) the Company Shares, 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, and (iii) the Over-allotment Shares, if, as and when issued by the Company and 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, BROBECK, PHLEGER & HARRISON LLP EX-10.11 4 SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT 1 EXHIBIT 10.11 CONFIDENTIAL TREATMENT HAS BEEN REQUESTED FOR CERTAIN REDACTED PROVISIONS OF THIS AGREEMENT. THE REDACTED PROVISIONS ARE IDENTIFIED BY THREE ASTERISKS AND ENCLOSED BY BRACKETS. THE CONFIDENTIAL PORTION HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION. INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY This Agreement is made between RESOLUTE SOFTWARE, INC. ("Licensee"), with offices at 4473 Willow Rd., Pleasanton, California 94588, and INXIGHT SOFTWARE, INC, A XEROX NEW ENTERPRISE COMPANY ("Inxight"), with offices at 3400 Hillview Avenue, Palo Alto, California 94304 and shall be effective as of the date of the last signature attached hereto. RECITALS Inxight has created or has the rights to certain linguistic and visualization technology, APIs and documentation. Licensee desires to acquire a right and license to incorporate Inxight Technology (as defined below) in certain Licensee Software (as defined below) for sub-license to customers, under the terms and conditions set forth in this Agreement; and Inxight is willing to grant such rights and licenses, and provide technical support as required; and In consideration of the mutual agreements contained in this Agreement, Inxight and Licensee hereby agree as follows: I. DEFINITIONS 1.01 "Inxight Technology" means all software owned or licensed by Inxight, in object code format, "C" Header Files and documentation identified in Attachment I hereof, subject to the provisions of paragraph 2.01, and shall include all ports, modifications, improvements, enhancements, additions, derivative works, updates, releases and versions thereof, as the same may be renamed or succeeded. 1.02 "LICENSED SOFTWARE" means any work derived from the combination of the Inxight Technology, in object code format only, and Licensee Software, which Licensee Software shall constitute a significant portion of the code and content of LICENSED SOFTWARE, and for which a royalty schedule has been defined in Attachment II and agreed to by the parties, subject to the provisions of paragraph 2.01. LICENSED SOFTWARE shall include all modifications, improvements, enhancements, additions, derivative works, updates, releases and versions thereof, whether created or developed by or on behalf of Licensee, LICENSED SOFTWARE will represent a significant enhancement and transformation of the Inxight Technology, which by objective examination of features and functions results in a product substantially different from the Inxight Technology, as the same may be renamed or succeeded. 1.03 "Licensee Software" means all software owned or licensed by Licensee, in object or source code format as applicable, subject to the provisions of paragraph 2.01, and shall include all ports, modifications, improvements, enhancements, additions, derivative works, updates, releases and versions thereof, as the same may be renamed or succeeded. 1.04 "Upgrade" shall mean the issuance of new releases of LICENSED SOFTWARE to customers who have previously executed a maintenance agreement with Licensee for LICENSED SOFTWARE. 1.05 "Sub-license" refers to the licensing of LICENSED SOFTWARE to third parties. Sub-license conveys no rights to Licensee to license Inxight Technology to third parties as standalone component technology, or to provide services to third parties based in whole or in part on Inxight Technology, unless specifically stated elsewhere in this Agreement. Page 1 2 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY 1.06 "Specifications" means all of the technical information, software and documentation described in Attachment I. II. TITLE TO LICENSED SOFTWARE, DERIVATIVE WORKS & MARKETING RIGHTS 2.01 Title to and ownership of the Inxight Technology resides in Inxight. Title to and ownership of Licensee Software resides in Licensee. Title to the LICENSED SOFTWARE created or developed using Inxight Technology by or on behalf of Licensee shall reside in Licensee. Licensee acknowledges that title to and ownership of Inxight Technology incorporated in the LICENSED SOFTWARE shall at all times remain with Inxight. All other applicable rights to patents, copyrights, trademarks, and trade secrets in Inxight Technology remain with Inxight and in Licensee Software shall remain with Licensee. 2.02 For all distribution, Licensee will require that any use of the LICENSED SOFTWARE will include copyright notices sufficient in substance to protect and preserve Inxight's copyright therein, in the same manner and form as Licensee uses to protect its own copyrights including, but not limited to, any manuals or other documentation and an appropriate screen (e.g., the start-up or "About" screen) of a product using the LICENSED SOFTWARE. Suggested attribution wording for collateral and web sites is shown in Attachment VII: Attribution. Any reproduction of any portion of the Inxight Technology by Licensee will include any proprietary and statutory copyright notices present in the originals received from Inxight unless otherwise stated in Attachment I. 2.03 When Licensee uses the Inxight Technology for research purposes, including, but not limited to processing text corpora for linguistic analysis or using the Inxight Technology as a part of a larger computer system, Licensee shall include a proper reference to the Inxight Technology in Licensee's published or unpublished reports, research articles or other written works. 2.04 Licensee is granted the right to use the Inxight name, copyright, logos, trade names and trademarks for the purposes of identification of the LICENSED SOFTWARE or Inxight Technology under this Agreement Inxight's name will be used only in an ethical and commercially reasonable manner, for the products licensed or developed under this Agreement. III. LICENSE GRANT 3.01 Inxight grants and conveys to Licensee a non-exclusive world-wide right and license to market, use, maintain, reproduce, distribute, display, and/or sub-license Inxight Technology, in object code format only, as incorporated in the LICENSED SOFTWARE and for which software a royalty schedule or a periodic license payment is set forth in Attachment II. Licensee may not make available in any form or expose Inxight Technology APIs, including the pass-through Inxight Technology APIs, or repackage the Inxight Technology APIs other than as specifically permitted by this Agreement. Licensee's rights may be exercised by itself or through its subsidiaries, distributors, resellers and agents ("Licensee's Distributors"). 3.02 This license does not grant any right to Licensee for the resale of services, based on Inxight Technology or any component or portion of the Inxight Technology, other than in the support of LICENSED SOFTWARE to Licensee customers, nor the right to offer the Inxight Technology or any component or portion of the Inxight Technology for sale without the LICENSED SOFTWARE. Sublicensing shall only be permitted as part of LICENSED SOFTWARE. Page 2 3 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY IV. ROYALTY 4.01 Licensee will pay Inxight royalties and/or license fees based on Licensee revenue billed by Licensee for LICENSED SOFTWARE, as defined in Attachment II entitled "ROYALTY / PERIODIC FEES." V. MARKETING OF LICENSED SOFTWARE 5.01 Inxight will provide to Licensee relevant marketing information in its possession, technical specifications, and update descriptions related to Inxight Technology for the primary purpose of promotion thereof as incorporated in the LICENSED SOFTWARE, so that Licensee can, on a periodic basis and as new changes or additions occur, distribute the same to its sales force and customers. During the term of this Agreement, Licensee may also include Inxight Technology product descriptions and information in any Licensee literature, including but not limited to Licensee's end-user reference materials, subject to appropriate copyright and trademark attribution. The distribution of such literature by Licensee will be at the expense of Licensee. Licensee may, at its option and expense, prepare its own promotional literature relating to Inxight Technology and the LICENSED SOFTWARE, and distribute the same to its sales force and customers. Inxight shall have the right to review and approve Licensee's use and representation of Inxight's information in Licensee's documentation and literature prior to its publication by Licensee. VI. ENHANCEMENTS TO TECHNOLOGY 6.01 During the term of this Agreement, Inxight will provide Licensee with BUG FIXES to BUGs reported by Licensee, according to the procedure outlined in Attachment III. Inxight will provide Licensee with any BUG FIXES, updates or revisions made generally available to other licensees or customers and will provide Licensee with new releases of the Inxight Technology. Any update, revision or modification or new release of the Inxight Technology so provided shall be covered by the provisions of this Agreement. 6.02 Inxight intends to enhance and further develop the Inxight Technology over the course of this Agreement. Licensee input to such development efforts is encouraged. Licensee may, at its discretion, provide Inxight with feedback relative to its use of Inxight Technology, including but not limited to errors and other corrective information, modifications, extensions (as used in Section 6.02 and 6.03 "extensions" relates only to the Inxight Technology and not to any layers of software pertaining to Licensee Software), and suggested changes relative to supporting documentation. 6.03 Licensee grants to Inxight an irrevocable, non-exclusive, royalty-free world-wide license covering any and all rights owned, controlled or licensable by Licensee relating to such corrections, modifications, extensions and supporting documentation of Inxight Technology pursuant to the foregoing paragraph 6.02. Inxight shall have the right under this license to make, have made, use, sell, lease, reproduce, prepare derivative works, including the right to any modifications or improvements and the like made at the suggestion of Licensee or based on the aforesaid feedback and to distribute, sub-license and otherwise dispose of any of the foregoing rights in connection with the licensed subject matter, and to sub-license others to perform any of these acts. 6.04 Inxight shall provide Licensee with reasonable notice of pending new releases of the Inxight Technology. 6.05 Licensee may request changes, modifications, or extensions to the Inxight Technology, which include enhancements to the product beyond those included in the Specifications. Such enhancement requests shall be considered by Inxight and enhancements may be incorporated into the Inxight Technology and delivered by Inxight at its own discretion. Inxight will be under no obligation to implement any such enhancements, unless agreed by the parties in writing as to content, schedule and fees for changes to the Specifications. In instances where Licensee is willing to provide compensation for certain enhancements, Licensee and Inxight shall execute a separate licensing agreement or an amendment of this Agreement specifying the additional terms. Page 3 4 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY VII. SPECIFICATIONS, DELIVERY AND ACCEPTANCE 7.01 Inxight shall deliver the Inxight Technology and Documentation (as defined in Attachment I) in accordance with the Specifications in Attachment I and the Deliverables Schedule in Attachment IV. 7.02 Acceptance Procedure Upon delivery of each release of the Inxight Technology to Licensee, Licensee shall: (a) Test and evaluate the Inxight Technology for a period of up to thirty (30) days and (b) Produce a list of changes and modifications needed to bring the Inxight Technology into conformance with the Specifications in Attachment I. Failure of Licensee to provide the list of changes and modifications needed, during this thirty-day period, constitutes acceptance of Inxight Technology. Upon receipt of the desired change list, Inxight will at no additional charge: (c) Correct BUGs and bring the Inxight Technology into conformance with the Specifications in accordance with Attachment I and Attachment III, and (d) deliver to Licensee an updated version of the Inxight Technology. 7.03 Inxight shall provide to Licensee a master run-time set of the Inxight Technology suitable for reproduction. Licensee may use the master set solely to create one back-up copy and to develop and produce products to be distributed to its customers in accordance with this Agreement. VIII. WARRANTY 8.01 Inxight represents and warrants that: (a) the Inxight Technology is substantially free from program errors or other problems, (b) the Inxight Technology performs in accordance with the Documentation, (c) the Inxight Technology meets the Specifications recited in Attachment I, and (d) the master of the medium on which the Inxight Technology is contained shall be free of physical defects, and contains no computer virus, worm, or other damaging or disabling defect or device. 8.02 If any BUGs are discovered by Licensee, subject to a valid maintenance agreement, Inxight shall endeavor to correct such BUGS, following receipt of notice from Licensee of such BUGs, in accordance with the procedure delineated in Attachment III - TECHNICAL SUPPORT. Product enhancements and other program modifications will be treated in accordance with the provisions of Article VI, paragraph 6.05. 8.03 Inxight represents and warrants that the Inxight Technology delivered under this Agreement is Year 2000 performance compliant and thus shall be able to accurately process date data (including, but not limited to, calculating, comparing, and sequencing) from, into, and between the twentieth and twenty-first centuries, including leap year calculations. 8.04 Inxight represents and warrants that it will make reasonable efforts to cause the Inxight Technology (Hyperbolic Tree for Windows and Java) to run correctly on new releases of Windows and Java within ninety (90) days of such new releases, provided that Inxight is informed of such new releases by Licensee. 8.05 EXCEPT FOR THE EXPRESS WARRANTIES SET FORTH IN THIS AGREEMENT, INXIGHT HEREBY DISCLAIMS AND LICENSEE EXPRESSLY WAIVES ANY AND ALL OTHER EXPRESS WARRANTIES OR REPRESENTATIONS OF ANY KIND OR NATURE, AND ANY AND ALL IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. IX. TECHNICAL SUPPORT 9.01 Inxight shall provide technical support and maintenance of Inxight Technology to Licensee in conformity with the terms and conditions defined in Attachment III, entitled "Technical Support." Page 4 5 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY X. TERMINATION 10.01 The term and renewal of this Agreement is delineated in Attachment II, Term of Agreement. 10.02 Either Inxight or Licensee may terminate this Agreement by written notice of termination to the other party upon: (a) A material breach by the other party which has not been cured within ninety (90) days of written notice of such breach, or in the case of a breach which cannot with due diligence be cured within a period of ninety (90) days, if the defaulting party has not instituted within the ninety (90) days steps necessary to remedy the default or prevent it from re-occurring and thereafter diligently followed such steps. However, prior to termination, the parties will make all reasonable efforts to resolve the dispute. The Confidential Obligations (the obligations as to CONFIDENTIAL INFORMATION, as defined below) herein and any other remedies available, such as return of fees, shall not be waived and shall survive termination, (b) A material breach which cannot be cured, (c) Subject to Section 16.01, the filing of a petition for reorganization, bankruptcy, assignment for the benefit of creditors or receivership by the other party, or (d) An unauthorized assignment by the other party under the term of Section 15.01 below. 10.03 Upon termination of this Agreement under Section 10.02 above, the license shall immediately cease and Licensee shall: (a) promptly cease the distribution of and/or the provision of services based on LICENSED SOFTWARE to any now sub-license partners, OEMs or end users. (b) promptly cease use of the LICENSED SOFTWARE incorporating the Inxight Technology, including its use on any processor, except as is required for providing maintenance to its existing customers. (c) promptly cease provision of services based in whole or in part on the Inxight Technology. (d) return the master copy of Inxight Technology and return or destroy all copies of Inxight Technology, including all ports and supporting Documentation. Licensee may, however, retain one (1) copy of the Inxight Technology and Documentation to be used solely for support purposes of Licensee and end users under a valid maintenance contract or for archival purposes. (e) certify in writing to Inxight, by a duly authorized officer of Licensee, that it has performed these acts, and the obligations under Articles II and XV shall remain in force until Licensee has performed these acts, 10.04 Upon Inxight's request, Licensee shall furnish to Inxight evidence of compliance with paragraph 1.02, of this Agreement. Licensee acknowledges and agrees that failure to comply shall be considered grounds for termination of this Agreement for material breach in accordance with paragraphs 10.02 and 10.03 above. 10.05 All valid Licensee sub-licenses, in effect on the date of termination, shall survive the termination of this Agreement. XI. INDEMNIFICATION 11.01 Inxight represents and warrants that it has sufficient right, title and interest in and to the Inxight Technology to enter into and perform this Agreement and further warrants that the Inxight Technology does not infringe any patent, copyright or other proprietary right of a third party and that it has not been Page 5 6 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY notified by a third party of a possibility that the Inxight Technology might infringe any patent, copyright or other proprietary right of a third party. 11.02 Inxight shall defend, indemnify and hold Licensee harmless from any claim, action or other proceeding brought against Licensee or a sub-licensee of the Inxight Technology and all settlements agreed to by Inxight and all costs and direct damages awarded to a third party to the extent they arise out of a claim alleging infringement by Inxight Technology of any U.S. patent or worldwide copyright or other proprietary right of a third party, providing that Licensee promptly notifies Inxight in writing of any action or claim, after it becomes aware of any such action or claim, and allows Inxight, at Inxight's expense, to direct the defense of any such action or claim, and gives Inxight full information and reasonable assistance required to defend any such suit claim or proceeding. This indemnity shall not apply to any alleged infringement caused by the combination of the LICENSED SOFTWARE with other third party software, products or modifications thereof when the alleged infringement is attributable to Licensee Software and would not have occurred but for said combination or modifications. To avoid infringement, Inxight may, at its option, and at no charge to Licensee, obtain a license or right to continue the use of the Inxight Technology, or modify the Inxight Technology so it no longer infringes, or substitute an equivalent of the Inxight Technology. 11.03 Inxight shall have no liability for any claim, action or other proceeding based on negligent acts or willful omissions by Licensee or a sub-licensee, or for settlements or costs incurred without the knowledge of Inxight Licensee shall have no liability for any claim, action or other proceeding based on negligent acts or willful omissions by Inxight or for settlements or costs incurred without the knowledge of Licensee. 11.04 Licensee shall defend, indemnify and hold Inxight harmless from any claim action, or other proceeding brought against Inxight and all settlements agreed to by Licensee and all costs and direct damages awarded to a third party to the extent they arise out of a claim that the portions of the LICENSED SOFTWARE other than the Inxight Technology infringe a U.S. patent, or worldwide copyright or other proprietary right of a third party, providing Inxight shall notify Licensee in writing of any action or claim, after it becomes aware of such claims, and allows Licensee at its expense to direct the defense of any such action or claim and gives Licensee full information and reasonable assistance required to defend any such suit, claim or proceeding. XII. DISCLAIMER 12.01 IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER FOR ANY SPECIAL, INDIRECT, INCIDENTAL OR CONSEQUENTIAL DAMAGES IN ANY WAY ARISING OUT OF THE USE OF THE INXIGHT TECHNOLOGY OR LICENSED SOFTWARE OR RELATING TO THIS AGREEMENT HOWEVER CAUSED UNDER A CLAIM OF ANY TYPE OR NATURE BASED ON ANY THEORY OF LIABILITY (INCLUDING CONTRACT, TORT OR WARRANTY) EVEN IF THE POSSIBILITY OF SUCH DAMAGES HAS BEEN COMMUNICATED. IN NO EVENT SHALL EACH PARTY'S LIABILITY TO THE OTHER FOR DIRECT DAMAGES EXCEED ONE MILLION ($1,000,000) DOLLARS, THE LIMITATIONS AND EXCLUSIONS IN THIS PARAGRAPH SHALL NOT APPLY TO THE INDEMNIFICATION OF ARTICLE XI. XIII. FORCE MAJEURE 13.01 Neither parry shall be liable to the other for its failure to perform any of its obligations hereunder during any period in which such performance is delayed by circumstances beyond its reasonable control, such as acts of government, nature, terrorism, or war, provided that the party experiencing such delay promptly notifies the other party of the delay, Page 6 7 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY XIV. CONFIDENTIAL INFORMATION 14.01 Licensee agrees not to intentionally disclose or intentionally make available to any third party information received from Inxight, which Inxight indicates is confidential at the time of disclosure (hereinafter referred to as "CONFIDENTIAL INFORMATION") in any form without the express written approval of Inxight. 14.02 Licensee shall not use such CONFIDENTIAL INFORMATION except to the extent necessary to perform under this Agreement and shall not intentionally circulate the CONFIDENTIAL INFORMATION within its own organization except to those with a specific need to know such CONFIDENTIAL INFORMATION. If written approval by Inxight is given to Licensee to disclose CONFIDENTIAL INFORMATION to a third party, Licensee shall impose similar confidentiality restrictions on such third party to whom it discloses such CONFIDENTIAL INFORMATION. 14.03 The obligations on Licensee recited in this Article XIV shall terminate with respect to any particular portion of such CONFIDENTIAL INFORMATION when and to the extent that it is or becomes: (a) part of the public domain through no fault of either party; (b) communicated by Inxight to a third party free of any obligation of confidence; (c) independently developed by Licensee without any reference to the CONFIDENTIAL INFORMATION; (d) known to Licensee free of any obligation of confidence, or (e) required to be disclosed by Licensee, by law, or to a competent court, government or regulatory body having the right to require same. 14.04 In no event shall the obligation of either party as recited in paragraph 14.02 with respect to the CONFIDENTIAL INFORMATION extend beyond three (3) years from the date of termination of this Agreement except for Inxight source code. 14.05 Upon request by Inxight after termination of this Agreement Licensee agrees to promptly return the CONFIDENTIAL INFORMATION. 14.06 Licensee agrees that: (a) it will use commercially reasonable efforts to ensure that Inxight Technology is distributed to third parties only according to procedures which do not compromise the licenses, security and copyrights of Inxight Technology; (b) it will not knowingly permit anyone to use Inxight Technology including portions thereof for the purpose of reverse-engineering; and (c) it will instruct its employees responsible for LICENSED SOFTWARE of the foregoing obligations and prohibitions. 14.07 Licensee shall safeguard the Inxight Technology and CONFIDENTIAL INFORMATION to the same extent that Licensee protects its own software, technology and confidential information, and shall sub-license the LICENSED SOFTWARE on the same protective terms under which Licensee licenses its own software. Licensee shall cause each unit of the LICENSED SOFTWARE incorporating Inxight Technology distributed by it or its OEMs or sub-licensors pursuant to this Agreement to be subject to a limited use software license agreement incorporating terms no less restrictive than those contained in this Agreement. Said software license agreement may be a written agreement signed by the end user, a written agreement contained and fully visible within the LICENSED SOFTWARE package that the end user accepts by opening the package, or the license terms of Licensee which the user accepts by clicking on the "I agree" button before installation. 14.08 Upon discovery of unauthorized transfers or misappropriations of CONFIDENTIAL INFORMATION, Licensee will: (a) inform Inxight of known details thereof, (b) give reasonable effort and assistance to Page 7 8 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY Inxight in the recovery and return of such CONFIDENTIAL INFORMATION; (c) provide all reasonably necessary assistance in the enforcement of Inxight's rights against any third party involved in such unauthorized transfer or misappropriation of CONFIDENTIAL INFORMATION, and (d) use reasonable endeavors to prevent further unauthorized transfer or misappropriation of CONFIDENTIAL INFORMATION. 14.09 Inxight shall have the same confidentiality and other obligations with respect to any software and documentation or other information disclosed by Licensee as Licensee has under Sections 14.01 through 14.08 with respect to CONFIDENTIAL INFORMATION disclosed by Inxight. XV. ASSIGNMENT 15.01 This Agreement may not be assigned or transferred by either party without the prior written approval of the other party, not to be unreasonably withheld or delayed; provided that Inxight may assign its rights, or any portion thereof, to Xerox Corporation or its subsidiaries or affiliates, and Licensee may assign its rights hereunder, or any portion thereof, to any subsidiary or affiliate of Licensee, in each case without the prior approval of the other party. For the purpose of this Section 15.01, a sale or transfer of all or substantially all of the assets, stock or business of the party shall be deemed an assignment; provided however, that a public offering of equity or debt shall not be deemed an assignment. Notwithstanding the foregoing, Inxight may assign its rights to any purchaser of all or substantially all of its Inxight Technology business without prior written approval, and Licensee may assign this Agreement or its rights hereunder or any portion thereof to any purchaser of all or substantially all of its business (a "Business Purchaser") without prior approval; provided that if Licensee transfers or otherwise assigns this Agreement to a Business Purchaser and such Business Purchaser assumes a distributor relationship with Licensee or further imbeds the LICENSED SOFTWARE as it exists on the date of assignment into another product or products such that the resulting product represents a significant enhancement or transformation of LICENSED SOFTWARE, then Inxight shall have the right to re-negotiate the license fee for the Inxight Technology to be effective following the transaction in good faith and consistent with Inxight's historical pricing structure; and provided further that if Inxight and the Business Partner are unable to agree on a re-negotiated license fee, then Inxight shall have the right to terminate this Agreement with such termination to be effective 60 days following notice to the Business Purchaser. For purposes of this Section 15.01, a distributor relationship shall mean a sale by Licensee to the Business Partner for purposes of re-sale by the Business Partner. Further, Licensee's rights and obligations under this Agreement may be exercised and performed in whole or in part by any subsidiary or affiliate of Licensee, provided that Licensee shall continue to be responsible to Inxight for the performance of its obligations under this Agreement. Subject to the limitations heretofore expressed, this Agreement shall inure to the benefit of and be binding upon the parties, their successors, administrators, heirs and assigns. Neither party may assign to any third party that is not able to fulfill the obligations of this Agreement. In the event that Licensee files for bankruptcy protection within the term of this Agreement the assignment of rights to LICENSED SOFTWARE by Licensee to any third party shall require the approval, in writing, of Inxight. XVI. BANKRUPTCY 16.01 To the extent permitted by applicable law (including II U.S.C. Section 365) the party not involved in the proceeding may terminate this Agreement immediately by written notice to the other party in the event the other party makes an assignment for the benefit of its creditors, the other party admits in writing an inability to pay debts as they mature, a trustee or receiver is appointed respecting all or a substantial part of the other party's assets, or a proceeding is instituted by or against the other party under any provision of the Federal Bankruptcy Act and is acquiesced in or is not dismissed within sixty (60) days, or results in an adjudication of bankruptcy. Page 8 9 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY XVII. PUBLICITY 17.01 Without the prior written consent of the other party, except as specified herein, neither Licensee, nor Inxight shall (a) make any news release, public announcement, public denial or confirmation of this Agreement or its subject matter, or (b) advertise or publish any facts or terms relating to this Agreement. Such consent shall not be unreasonably withheld or delayed. 17.02 Licensee and Inxight agree to make a joint press release to announce this Agreement and strategic partner relationship as soon as feasible after the execution of this Agreement Both parties will cooperate with and support the other party in its press release materials, and provide reasonable efforts in support of an event, if any, sponsored by the other party to highlight the LICENSED SOFTWARE. 17.03 Licensee will prominently feature Inxight Technology in press announcements (as the parties shall agree) regarding LICENSED SOFTWARE and have Inxight Technology's brand identity and logo included in all announcement materials, promotional materials and programs associated with the LICENSED SOFTWARE, to the extent said materials and programs materially portray or discuss Inxight Technology. XVIII. COOPERATIVE MARKETING 18.01 Licensee and Inxight agree to cooperate in and pursue future product development and marketing arrangements with regard to LICENSED SOFTWARE and other products and services of interest to both parties. Each such cooperative arrangement shall be mutually agreed between the parties. 18.02 Licensee will provide a hypertext link from Licensee's Internet page for LICENSED SOFTWARE to the Inxight page specified by Inxight. To the extent that Inxight's Internet page for Inxight Technology includes hypertext links or references to third party licensees of Inxight Technology, the page shall also include a hypertext link or reference to Licensee's website. XIX. CONTROLLING LAW 19.01 This Agreement shall be governed and construed in accordance with the laws of the United States and the State of California. XX. GENERAL PROVISIONS 20.01 WAIVER FAILURE of either party to require strict performance by the other party of any provision of this Agreement shall not affect the first party's right to require strict performance thereafter. Waiver by either party of a breach of any provision of this Agreement shall not waive either the provision itself or any subsequent breach. 20.02 NO AGENCY It is agreed and understood that neither Licensee nor Inxight has any authority to bind the other with respect to any matter hereunder. Under no circumstances shall either Licensee or Inxight have the right to act or make any commitment of any kind to any third party on behalf of the other or to represent the other in any way as an agent. 20.03 SURVIVAL The provisions of this Agreement shall, to the extent applicable, survive the expiration or any termination hereof. 20.04 HEADINGS The headings and titles of the sections of this Agreement are inserted for convenience only, and shall not affect the construction or interpretation of any provision of this Agreement. 20.05 SEVERABILITY If any provision of this Agreement is held invalid by any law, rule, order of regulation of any government or by the final determination of any state or federal court, such invalidity shall not affect the enforceability of any other provisions of this Agreement not held to be invalid. Page 9 10 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY 20.06 U.S. GOVERNMENT RESTRICTED RIGHTS For purposes of U.S. Government restricted rights, the Inxight Technology has been developed completely at private expense and is vended pursuant to its applicable license agreement. 20.07 EXPORT Licensee agrees that it will not export or reexport the Inxight Technology or the LICENSED SOFTWARE without the appropriate United States Government or any other government licenses. 20.08 ENTIRE AGREEMENT This Agreement constitutes the entire agreement of the parties as to the subject matter hereof and supersedes any and all prior oral or written memoranda, understandings and agreements as to such subject matter. This Agreement shall not be modified, except by a written agreement signed by duly authorized representatives of Inxight and Licensee. XXI. ATTACHMENTS 21.01 THE TERMS AND CONDITIONS OF ATTACHMENTS ["I," "II," "III," "IV," "VII" AND "VIII"] ARE ATTACHED HERETO AND MADE A PART HEREOF. IN WITNESS WHEREOF, the parties have hereunto set their hands. Resolute Software, Inc. Inxight Software, Inc. By: /s/ Daniel Callahan By: /s/ Steve Katz ------------------------ ----------------------------- Name: Daniel Callahan Name: Steve Katz Title: CEO Title: VP World Sales ---------------------- ------------------------ Date: 9/30/98 Date: 9/30/98 ---------------------- ------------------------ Send all business correspondence pertaining to this Agreement to: Resolute: Inxight: - -------- ------- Chief Financial Officer Director Business Development 4473 Willow Road Inxight Software, Inc. Pleasanton, CA 91588 3400 Hillview Avenue Palo Alto, CA 94304 Page 10 11 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT I - VZ: VISUALIZATION SPECIFICATIONS Licensee may be granted a license for one or more of the Inxight Technologies ("VizControls") listed in this Attachment I. The specific Inxight Technologies licensed under this Agreement are detailed in Attachment IV: Deliverables. HYPERBOLIC TREE(TM) The Hyperbolic Tree is a general-purpose user interface component for interacting with large hierarchies containing thousands of nodes. It leverages many of the principles articulated and exploited in over 10 years of research and invention at Xerox PARC (Palo Alto Research Center) on the next-generation of user interfaces. These principles include Focus+Context(TM) display, rendering information graphically and animating transitions. Hyperbolic Tree(TM) is protected by Inxight/Xerox Patents and includes the Inxight Technology definition stated in paragraph 1.0 1 of this Agreement and one or more of the following sets of elements: Hyperbolic Tree for Windows: - ---------------------------- Hyperbolic Tree for Windows consists of a set of ActiveX component classes and externally exposed interfaces for programming in C++, MFC and Visual Basic. It includes complete API documentation, including class hierarchy and description of mechanisms for customization and data integration and a sample application (including source code) intended to provide an example of how a client application should use Inxight's toolkit. The sample application also demonstrates the standard data component that supports the building of Hyperbolic Tree displays from XML files. Hyperbolic Tree for Java: - ------------------------- The Hyperbolic Tree for Java (HTJ) contains the classes and documentation to implement applets and applications that employ the Hyperbolic Tree visualization. It includes complete documentation, including class hierarchy and description of mechanisms for customization and data integration and a sample, application (including source code) intended to provide an example of how a client application should use Inxight's toolkit. The sample application also provides a simple dataset loader that supports the building of Hyperbolic Tree displays from structured text files. Hyperbolic Tree(TM) is a user interface component that can be utilized to display a large hierarchy in a manner that facilitates user interaction. DOCUMENTATION Documentation means currently available written technical information, including user manuals, software specifications and installation instructions, provided by Inxight for Licensee's internal use in integrating Inxight Technology into LICENSED SOFTWARE. Page 11 12 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT II: ROYALTY / PERIODIC FEES In consideration of the rights granted Licensee by Inxight in this Software Distribution & License Agreement of which this Attachment II is a part, Licensee shall pay to Inxight the Royalties and Periodic Fees listed herein. Said Royalties and Fees relate only to the deliverables noted in the Deliverables Schedule - Attachment IV, and to other matters as may be detailed in this Attachment II. I. TERM OF AGREEMENT: This Agreement is for a term of four (4) years, and shall be non-cancelable without cause. It shall automatically renew for two-year periods therefrom, unless terminated by either party at the conclusion of the initial term or at any subsequent extension thereof, upon thirty (30) days written notice to other party. In the event of termination by Inxight under this provision, Licensee shall have two (2) years from the date of termination to comply with Section 10.03 of this Agreement. II. MAINTENANCE FEE: Maintenance represents the annual fee paid by Licensee for BUG fixes, updates, revisions and modifications to Inxight Technology and for new releases, in accordance with the Specifications of Attachment I and the Technical Support considerations of Attachment III. Annual Maintenance charges under this Agreement shall be [***] dollars per year, the Maintenance Fee shall be due and payable upon the delivery by Inxight of the Initial Deliverables (Attachment IV, DELIVERABLES SCHEDULE) and annually thereafter on such anniversary date. Annual Maintenance charges under term renewals to this Agreement (after the initial 4 year term) shall not increase more than [***] per annual renewal period. III. ROYALTY: A Royalty fee is charged for the license to use and distribute the Inxight Technology in the LICENSED SOFTWARE as per the license grant in paragraph 3.01 of the Agreement Licensee shall pay to Inxight the Royalty shown below. The Royalty Rate for LICENSED SOFTWARE shall be [***] percent of Billed Revenue (defined as all gross revenue derived from the sales of LICENSED SOFTWARE less sales tax, shipping charges, and returns). Training, maintenance, and consulting services revenue associated with Resolute Application Performance System (RAPS) or LICENSED SOFTWARE are excluded from Billed Revenue. Royalty fees will begin to accrue on the date of First Customer Ship of the Licensed Software or September 30, 1999, whichever occurs first. The parties specifically acknowledge that the provision of any Upgrade of LICENSED SOFTWARE by Licensee to its customers, pursuant to a maintenance agreement to such customers, will not trigger the requirement of Licensee to pay the above referenced Royalty to Inxight. To the extent, however, that Licensee invoices for such Upgrade, independent of invoicing with regard to annual maintenance, Licensee shall be obligated to pay the applicable Royalty referenced above. Licensee may provide the initial release version of Licensed Software as a no charge upgrade to no more than twenty-five (25) then current customers without royalty obligation. IV. ROYALTY RATE REDUCTION OPTION: Licensee is granted an option to reduce the contract royalty rate of [***] Percent to [***] Percent by paying an additional Advance Payment of [***] dollars plus a one-time Option Fee of [***]. Both the Advance Payment and Option Fee (total [***]) are due and payable at time of option exercise. Should this Royalty Rate Reduction Option be exercised, the new [***] royalty will become effective on the first day of the month following the option execution and payment of the [***] fees. This option is valid only if exercised by March 31, 2000 or during the 30 day period prior to the expiration of the initial four-year term of the Agreement or during the 30 day period prior to the expiration of any subsequent term of the Agreement. [***] Confidential treatment has been requested for redacted portion. The confidential redacted portion has been omitted and filed separately with the Securities and Exchange Commission. Page 12 13 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY V. ADVANCE PAYMENT: Licensee shall make a non-refundable Advance Payment to Inxight in the amount of [***] dollars The [***] Advance Payment shall be invoiced on contract execution and payable per the following schedule: o Within thirty (30) days of receipt of invoice: [***]. o On June 30, 1999: [***]. Royalties due to Inxight shall be credited against the Advance Payment at a 100% rate until the Advance has been depleted. Unused Advance balances in the initial contract term shall not be carried forward to any contract renewal term. Licensee may add Hyperbolic Tree for Active X(TM) at any time over the term of this Agreement for an additional Advance Payment of [***] dollars. Then-current royalty rates will also apply to sales of LICENSED SOFTWARE incorporating Hyperbolic Tree for Active X(TM). Failure to make the Advance Payments on a timely basis shall be considered a material breach of contract, subject to the provisions of paragraphs 10.02 and 10.03 of this Agreement. VI. NON-COMMERCIAL USE: No royalties shall be due from Licensee for units of LICENSED SOFTWARE which are used for testing, evaluation, support, marketing, publicity, demonstration or training purposes, unless commercial revenue is received by License for such use. LICENSED SOFTWARE used by Licensee for or in conjunction with internal business operations purposes shall be subject to licensing arrangements to be agreed by the parties. VII. CONSULTING SERVICES/CUSTOM EFFORTS: Requests for custom effort with regard to Inxight Technology, if agreed by the parties, will be charged at the prevailing daily rate which is currently [***], per senior software developer. Travel and other out-of-pocket expenses incurred by Inxight in the delivery of consulting services shall be billed to and promptly paid by the Licensee. VIII. PAYMENT AND REPORTING: Within thirty (30) days after the end of each calendar quarter during the term hereof, Licensee shall provide Inxight with a written report setting forth the amount of billed revenue, by product, related to the LICENSED SOFTWARE and the royalties due to Inxight for that quarterly period. A check or wire transfer of funds shall accompany the report. IX. AUDIT: Licensee shall, for a period of two (2) years following the date of each report issued, keep records adequate to verify the substance of the report and any accompanying payment. Inxight shall have the right once each calendar year, to select a mutually acceptable independent Certified Public Accountant to inspect the records of Licensee at a single location on reasonable notice and during regular business hours to verify the reports and payments made hereunder. The entire cost of such inspection shall be borne by Inxight, and such Certified Public Accountant shall not disclose to Inxight any information other than information relating to the computation and accuracy of such reports and payments. Any information as to Licensee's, customers will be treated as Licensee CONFIDENTIAL INFORMATION and shall not be disclosed. If the audit reveals that Licensee has under-reported revenues of LICENSED SOFTWARE by more than five percent (5%) in any calendar year, Licensee shall reimburse Inxight for the audit fees. In any event the report of the Certified Public Accountant shall be accepted by the parties and the Licensee shall promptly pay, or apply against any outstanding prepaid Annual Fees, the underpayment as well as the interest on the unpaid balance, at the maximum interest rate allowed by law. [***] Confidential treatment has been requested for redacted portion. The confidential redacted portion has been omitted and filed separately with the Securities and Exchange Commission. Page 13 14 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT III - TECHNICAL SUPPORT DEFINITIONS "Customer" means the Licensee's end-user or OEM customer using or integrating the LICENSED SOFTWARE, subject to a valid license and maintenance agreement with Licensee. "Software Release" means any version of the Inxight Technology shipped to any customer. "Data Modules" are files containing language-specific information which are accessed by the Runtime Libraries. They are part of the Inxight LinguistX(TM) Technology as described in Attachment 1. "Version Number" is a label that uniquely identifies a particular version of the Runtime Libraries or Data Modules of a Software Release. Each VERSION NUMBER consists of two or three integers delimited by periods (`.'). "Major Versions" are new Software Releases containing major feature, functional, and/or API changes over previous releases. In a new Major Version, the first integer of the Version Number will be incremented over that of the previous Major Version. "BUGS" refers to and is defined as any: (a) typographical error, including errors in the Documentation, (b) entry with a wrong lexical marking, (c) functional or operational error or fault that is not caused by (i) missing words or names, (ii) inaccurate input of data by Licensee or end-user, or (iii) unauthorized alteration or modifications of the LICENSED SOFTWARE, (d) incorrect or incomplete statement or diagram in the Documentation, or (e) non-conformance of the Inxight Technology with its Specifications referenced in Attachment I. "BUG FIXES" means modifications or revisions to source code or object code or Documentation which correct BUGs and other deviations from the Specifications. BUG FIXES shall consist of Inxight using reasonable efforts to design, code, and implement programming changes to Inxight Technology and modifications to the documentation in order to correct BUGs such that Inxight Technology is brought into conformance with the Specifications listed in Attachment I. "Unilateral Enhancements" are changes to Inxight Technology, which Inxight does as a consequence of its normal business operations and ensuing BUG FIXES for others than Licensee, with the aim of keeping the Inxight Technology up-to-date and according to the Specifications. The process with respect to the treatment of Enhancement Requests is defined in paragraph 6.05 of the Agreement. MAINTENANCE LOCATION All BUG FIXES provided under this Agreement shall be provided at Inxight's facilities, unless Inxight and Licensee mutually agree that it is necessary to provide such services at Licensee's facilities VERSION COMPATIBILITY Inxight will support backward compatibility for the immediately preceding MAJOR VERSION of Runtime Libraries. Specifically, a Runtime Library will support its own API and that of any preceding release with the same or immediately preceding MAJOR VERSION number. It will also support any DATA MODULE with the same or immediately preceding MAJOR VERSION number. Commencing with the SOFTWARE RELEASE of a new MAJOR VERSION, Inxight does not guarantee support for Runtime Libraries or DATA MODULES with a MAJOR VERSION number less than the immediately preceding MAJOR VERSION. Page 14 15 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY RESPONSIBILITY 1. Licensee shall report to Inxight any deviations from the Specifications of the Inxight Technology (BUGS) which are discovered during the term of this Agreement. 2. Inxight will provide BUG FIXES to Licensee for the then current and the immediate predecessor releases of Inxight Technology, as Licensee's customers may require from Licensee in order for Licensee to fulfill its maintenance obligations to its customers. Inxight will not provide BUG FIXES directly to any customers, unless Inxight enters into a separate maintenance agreement with such customers. Unilateral enhancements to Inxight Technology, if any, shall be provided by Inxight at no charge to Licensee in the course of issuing updates to Inxight Technology. 3. Inxight shall provide to Licensee any BUG FIXES, whether or not discovered by Licensee, as Inxight develops and makes available to any other licensee of the, Inxight Technology during the term of this Agreement. Licensee shall have no obligation to include any such BUG FIXES in LICENSED SOFTWARE. 4. Should Inxight discontinue all maintenance and distribution of the Inxight Technology, a copy of the source code and BUG FIXES and product modification records shall be made available to the Licensee as CONFIDENTIAL INFORMATION in order for Licensee to fulfill its maintenance obligations to it Customers. BUG REPORTING PROCEDURES E-mail shall be the primary means for the Licensee to report BUGS. The Licensee shall be provided with a dedicated e-mail address for technical support. This mailbox shall be monitored by Inxight throughout each normal day of business operation (Mondays through Fridays excluding holidays, 8AM - 6 PM Pacific Time). The Licensee shall also be provided with a telephone number dedicated to technical support. This phone will be answered, or monitored for messages, throughout each normal day of business operation. Messages may be left at this telephone number after normal business hours. RESPONSE TIME For each BUG FIX, Licensee and Inxight will follow the procedures outlined below: 1. Licensee or Licensee's customer logs a BUG; Licensee determines that BUG is related to Inxight Technology and not to LICENSEE SOFTWARE. 2. Request is sent by Licensee to Inxight via e-mail or telephone. 3. Inxight acknowledges receipt of request and reaches agreement with Licensee as to whether the BUG is related to Inxight Technology. 4. If it is determined that the BUG is related to Inxight Technology, Inxight classifies the BUG according to its BUG Classification Table following. 5. Inxight responds to Licensee, as per the BUG Classification Table, identifying the nature and the cause of the problem, if known, and (a) an estimated BUG FIX date; or (b) a workaround or update, if such is available; or (c) an action plan for the identification and resolution of the BUG FIX. Such action plan may mean inclusion of the necessary corrections or modifications in future releases or no remedial action at all if none is warranted. During this process, Inxight may request test cases or other data from the customer in order to reproduce the BUG. Page 15 16 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY Inxight VizControls(TM) Technology BUG Classification Table
PROBLEM DESCRIPTION INXIGHT RESPONSE - ------------------------------------------------------------ ------------------------------------- 1. Problem Solved. Case closed. 2. Minor Problem. Customer is having a problem Action is taken within 4 working (inconvenience or annoyance) with a feature or function days; A solution, action plan or related to Inxight Technology or requests a product rejection statement is issued. improvement or enhancement. The LICENSED SOFTWARE executes with no significant impact or special actions required by the user. There is no significant impact to production. 3. Moderate Problem. Customer is having a problem on his Action is taken within 48 hours to workstation with Inxight Technology that is preventing the solve the problem. A solution or use of LICENSED SOFTWARE or that requires special action plan for resolution is issued. work-around actions by the user. The system is up but Status updates are provided every production capability is reduced. The LICENSED SOFTWARE four business days. executes without crashing, but non-critical product features or functions may not be operable. There is no loss of data. Indicators are: inability of a no-critical application to run, continuing but infrequent failure requiring operational intervention, or non-critical product feature or function does not work. 4. Severe Problem. Inxight Technology causes a crash of Action is taken within 24 hours to LICENSED SOFTWARE, either directly through its own execution resolve the problem. A solution is or indirectly by mutilating other data in a manner that provided or an action plan is issued. causes a subsequent crash or data loss. The problem is Status updates are provided every two characterized by the inability of some critical application business days until the problem is to run; the failure requires frequent operational solved; there is priority assignment intervention, and/or there is a recoverable loss of data. of relevant resources to problem resolutions. 5. Critical Problem. Inxight Technology causes LICENSED Immediate action is taken to correct SOFTWARE to crash the machine or lock-up the system. Users the problem; daily status reports are cannot access LICENSED SOFTWARE and have no production issued until the problem is resolved; capability. The problem is characterized by inability to run there is priority assignment of critical applications on the server and/or unrecoverable relevant resources to problem loss of data. resolution.
With respect to ENHANCEMENT REQUESTS, Inxight makes no commitments as to response time, but will endeavor, to the extent resources are available, to evaluate the requested enhancement and to provide estimates of the time and cost to accomplish same. If applicable, Licensee initiates discussions with Inxight on the fee for the proposed enhancement. SERVICE OBLIGATION The services set forth herein shall be expressly contingent upon Licensee: (1) Promptly reporting any errors in the Inxight Technology or related documentation to Inxight in writing; (2) Not modifying the Inxight Technology without written consent of Inxight; (3) Utilizing the Inxight Technology only in accordance with the provisions hereof and the Specifications in Attachment I; and (4) Remaining current with respect to the annual Maintenance fees delineated in Attachment II. Page 16 17 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT IV: DELIVERABLES Inxight Technology with respect to this Agreement and License Grant refers only to Inxight Hyperbolic Tree(TM) for Java(TM): software, operating under Java(TM) operating systems, as indicated below, for integration with Licensee software to form the LICENSED SOFTWARE application. Unless otherwise noted herein, all software will be provided in run-time format. DELIVERABLES SCHEDULE Inxight shall make commercially reasonable efforts to deliver VizControls(TM) Technology components in accordance with the schedule which follows. The following components shall be considered the "Initial Deliverable" for purposes of this Agreement. A. VizControls(TM) Hyperbolic Tree(TM) Release 1.2 for Java(TM): Within five (5) business days of Agreement execution. B. All Documentation associated with VizControls(TM) Hyperbolic Tree(TM) Release 1.2 for Java(TM). VizControls(TM) will be provided in run-time format, except for source code and accompanying Unix make files for the porting of the Runtime Libraries to Licensee's supported platforms. LICENSED SOFTWARE LICENSED SOFTWARE is defined in paragraph 1.02 of the Agreement and includes Licensee Software and Inxight Technology. Licensee Software refers to Licensee's application and IT infrastructure management software, and its applications, derivatives, and networks, as the same may be renamed or succeeded. ACCEPTANCE CRITERIA Acceptance of the Inxight Technology shall be contingent upon completion of the Acceptance Procedure described in 7.02 of the Agreement with respect to the functions and performance specifications set forth in Attachment I. TECHNICAL CONTACTS / LIAISON Inxight and Licensee will each designate individuals who will serve as technical liaisons for the term of the Agreement. The initial technical contacts win be: RESOLUTE SOFTWARE, INC. INXIGHT SOFTWARE, INC. - ----------------------- ---------------------- Vice President, Engineering Andy Gelman Resolute Software, Inc. Inxight Software, Inc. 4473 Willow Road 3400 Hillview Avenue Pleasanton, CA 94588 Palo Alto, California 94304 (925) 737-4000 650-813-7194 COPYRIGHT NOTICE Inxight, VizControls and all Inxight product names are trademarks of Inxight Software, Inc., Copyright (c) 1996, 1997 Inxight Software, Inc. All Rights Reserved. Java and Solaris are trademarks of Sun Microsystems, Inc. Windows, ActiveX and NT are trademarks of Microsoft Corporation. Page 17 18 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT VII: ATTRIBUTION Inxight requests that the wording below or wording which is substantially similar be included in Licensee's product documentation, marketing collateral, press releases and web sites. o References to LinguistX(TM), VizControls(TM), Xerox(R) and Inxight Software(TM) or any of the Inxight Technology (name components) subject to this license. Such references may be in the form of attribution or in the body of LICENSED SOFTWARE. o Splash Screen and Readme File attribution for the setup and the application, and in the About box: Contains LinguistX(TM)or VizControls(TM)(name components) from Inxight Software, Inc., a Xerox New Enterprise Company, Copyright (C) 1996-1997. All rights reserved. www.inxight.com. o Documentation and collateral. Legal Notices should contain the following attribution statement: LinguistX(TM) and VizControls(TM) (name components) from Inxight Software, Inc., a Xerox New Enterprise Company, Copyright (C) 1996-1997. Xerox(R), Inxight(TM), Linguist(TM)` and VizControls(TM) are trademarks of Xerox Corporation and Inxight Software, Inc. LinguistX(TM) and VizControls(TM) contain patented technology of Xerox Corporation. All rights reserved. o Inxight shall provide guidelines for attribution on Licensee's website and LICENSED SOFTWARE interface. Page 18 19 INXIGHT/RESOLUTE SOFTWARE: SOFTWARE DISTRIBUTION AND LICENSE AGREEMENT INXIGHT TECHNOLOGY ATTACHMENT VIII: SOURCE CODE ESCROW During the term of this Agreement, upon delivery to Licensee of each accepted version of the Inxight Technology, Inxight shall place the Inxight Technology Source Code into escrow with the General Counsel of Xerox Corporation ("Xerox"). If during the term, majority control of Inxight passes from Xerox to a third party or upon the request of Licensee, the then current version of the Inxight Technology Source Code shall be placed in escrow with a mutually agreed upon escrow agent. In each case, the escrow shall be for the benefit of Licensee. The Inxight Technology Source Code shall be released to Licensee if Inxight fails to perform its obligation to maintain Inxight Technology, subject to the provisions of Attachment III, sub-section RESPONSIBILITY, paragraph 4, or its obligations with regard to Inxight Technology Source Code. The parties will agree on an escrow agreement within 90 days of executing this Agreement. Page 19 EX-23.1 5 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE To the Board of Directors and Stockholders of Quest Software, Inc. and subsidiaries We consent to the use in this Amendment No. 2 to Registration Statement No. 333-30816 of Quest Software, Inc. on Form S-1 of our report dated February 1, 2000 (except for Note 12 as to which the date is February 11, 2000) relating to the financial statements of Quest Software, Inc. and our report dated February 22, 2000 relating to the financial statements of Foglight Software, Inc. 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 of Quest Software, Inc. also included the financial statement schedule of Quest Software, Inc. and subsidiaries, listed in Item 16. This financial statement schedule is the responsibility of the corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California March 1, 2000 EX-23.2 6 CONSENT OF SWENSON ADVISORS LLP 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the use in the Prospectus constituting part of this Registration Statement (No. 333-30816) on Form S-1 of our report dated September 29, 1999 relating to the financial statements of MBR Technologies, Inc., which appears in such Prospectus. We also consent to the references to us under the headings "Experts." SWENSON ADVISORS, LLP Temecula, California March 2, 2000 EX-23.3 7 CONSENT OF PRICEWATERHOUSE COOPERS LLP 1 EXHIBIT 23.3 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Registration Statement on Amendment No. 2 to Form S-1 of our report dated September 13, 1999, except for Note 10, for which it is October 29, 1999 relating to the financial statements and financial statement schedules of Foglight Software, Inc. as of December 31, 1998 and for the period from November 10, 1997 (date of inception) to December 31, 1998, which appear in such Registration Statement. We also consent to the references to us under the headings "Experts" and "Selected Financial Data" in such Registration Statement. /s/ PricewaterhouseCoopers LLP San Jose, California March 2, 2000 -----END PRIVACY-ENHANCED MESSAGE-----