10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

COMMISSION FILE NO. 000-26937

QUEST SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Delaware	33-0231678
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
5 Polaris Way Aliso Viejo, California	92656
(Address of principal executive offices)	(Zip code)

Registrant’s telephone number, including area code: (949) 754-8000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	x	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No   x

The number of shares outstanding of the registrant’s Common Stock as of July 29, 2010, was 90,295,612.

QUEST SOFTWARE, INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

		Page Number
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Income Statements	4
	Condensed Consolidated Statements of Cash Flows	5
	Condensed Consolidated Statements of Comprehensive Income	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Overview	23
	Results of Operations	25
	Liquidity and Capital Resources	31
	Recently Adopted Accounting Pronouncements	33
	Critical Accounting Policies and Estimates	33
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	35
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 6.	Exhibits	38
Signatures		39

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

QUEST SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)

	June 30 2010		December 31 2009
ASSETS
Current assets:
Cash and cash equivalents	$	316,148	$	292,940
Restricted cash		67		796
Short-term investments		54,248		90,109
Accounts receivable, net of allowances of $4,483 and $5,605 at June 30, 2010 and December 31, 2009, respectively		120,161		157,534
Prepaid expenses and other current assets		17,285		32,178
Deferred income taxes		11,100		11,832
Total current assets		519,009		585,389
Property and equipment, net		71,265		70,051
Long-term investments		68,743		2,411
Intangible assets, net		61,696		76,072
Goodwill		671,228		670,481
Deferred income taxes		29,651		34,127
Other assets		26,281		26,607
Total assets	$	1,447,873	$	1,465,138
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,662	$	3,714
Accrued compensation		39,741		45,831
Other accrued expenses		30,198		31,902
Income taxes payable		4,186		—
Loans payable		543		32,602
Deferred revenue		285,970		285,907
Total current liabilities		365,300		399,956
Long-term liabilities:
Deferred revenue		83,078		86,231
Income taxes payable		44,433		44,433
Loans payable		33,013		33,292
Other long-term liabilities		7,097		8,434
Total long-term liabilities		167,621		172,390
Total liabilities		532,921		572,346
Commitments and contingencies (Note 15)
Stockholders’ equity:
Preferred stock, $0.001 par value, 10,000 shares authorized; no shares issued or outstanding		—		—
Common stock, $0.001 par value, 200,000 shares authorized; 90,000 and 90,202 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively		90		90
Additional paid-in-capital		678,503		689,385
Retained earnings		236,132		203,130
Accumulated other comprehensive income		227		187
Total stockholders’ equity		914,952		892,792
Total liabilities and stockholders’ equity	$	1,447,873	$	1,465,138

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

QUEST SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended June 30					Six Months Ended June 30
	2010			2009		2010			2009
Revenues:
Licenses	$	77,100		$	61,639	$	142,081		$	124,009
Services		109,002			102,618		215,192			205,845
Total revenues		186,102			164,257		357,273			329,854
Cost of revenues:
Licenses		1,893			1,873		3,714			3,542
Services		15,636			14,499		30,360			28,260
Amortization of purchased technology		3,965			4,626		8,458			9,941
Total cost of revenues		21,494			20,998		42,532			41,743
Gross profit		164,608			143,259		314,741			288,111
Operating expenses:
Sales and marketing		72,082			65,490		140,422			132,028
Research and development		36,543			35,510		72,016			73,206
General and administrative		19,836			17,678		39,173			36,200
Amortization of other purchased intangible assets		3,149			3,261		6,325			6,667
Total operating expenses		131,610			121,939		257,936			248,101
Income from operations		32,998			21,320		56,805			40,010
Other (expense) income, net		(3,843	)		4,780		(7,449	)		634
Income before income tax provision		29,155			26,100		49,356			40,644
Income tax provision		11,764			5,641		16,353			10,256
Net income	$	17,391		$	20,459	$	33,003		$	30,388
Net income per share:
Basic	$	0.19		$	0.22	$	0.37		$	0.32
Diluted	$	0.19		$	0.21	$	0.36		$	0.32
Weighted-average shares:
Basic		89,434			94,381		89,548			94,355
Diluted		91,920			96,129		92,135			95,978

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

QUEST SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Six Months Ended June 30
	2010			2009
Cash flows from operating activities:
Net income	$	33,003		$	30,388
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		21,779			24,646
Compensation expense associated with share-based payments		9,171			7,331
Deferred income taxes		5,025			3,792
Unrealized losses (gains) on auction rate securities, net of losses from put options		8			(402	)
Excess tax benefit related to stock-based compensation		(1,318	)		(292	)
Provision for bad debts		531			61
Other non-cash adjustments, net		144			60
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable		33,258			44,064
Prepaid expenses and other current assets		4,230			810
Other assets		1,955			(650	)
Accounts payable		(388	)		(3,298	)
Accrued compensation		(7,115	)		(7,039	)
Other accrued expenses		(4,051	)		(9,458	)
Income taxes payable		8,719			(6,307	)
Deferred revenue		(3,089	)		(14,169	)
Other liabilities		(1,282	)		3,027
Net cash provided by operating activities		100,580			72,564
Cash flows from investing activities:
Purchases of property and equipment		(6,831	)		(3,940	)
Change in restricted cash		874			1,664
Purchases of cost method investments		—			(3,000	)
Purchases of investment securities		(132,283	)		—
Sales and maturities of investment securities		107,246			540
Notes receivable from a cost method investee		(2,000	)		—
Acquisition related payments		(981	)		—
Net cash used in investing activities		(33,975	)		(4,736	)
Cash flows from financing activities:
Repayment of loans payable		(32,339	)		—
Repurchase of common stock		(37,373	)		(3,916	)
Repayment of capital lease obligations		(133	)		(126	)
Cash paid for line of credit fees		—			(1,979	)
Proceeds from the exercise of stock options		23,297			4,663
Excess tax benefit related to share-based compensation		1,318			292
Net cash used in financing activities		(45,230	)		(1,066	)
Effect of exchange rate changes on cash and cash equivalents		1,833			383
Net increase in cash and cash equivalents		23,208			67,145
Cash and cash equivalents, beginning of period		292,940			215,895
Cash and cash equivalents, end of period	$	316,148		$	283,040
Supplemental disclosures of consolidated cash flow information:
Cash paid for interest	$	1,715		$	2,353
Cash paid for income taxes	$	2,319		$	11,337

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

QUEST SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	Three Months Ended June 30					Six Months Ended June 30
	2010			2009		2010			2009
Net income	$	17,391		$	20,459	$	33,003		$	30,388
Other comprehensive (loss) income:
Unrealized (loss) income on foreign currency hedges, net of tax		(388	)		—		51			—
Unrealized loss on available-for-sale securities, net of tax		(4	)		—		(11	)		—
Comprehensive income	$	16,999		$	20,459	$	33,043		$	30,388

The accompanying notes are an integral part of these condensed consolidated financial statements.

6

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 — ORGANIZATION AND BASIS OF PRESENTATION

Quest Software, Inc. was incorporated in California in 1987 and reincorporated in Delaware in 2009. We are a leading developer and vendor of application, database, Windows and virtualization management software products. We also provide consulting, training, and support services to our customers. References to “Quest,” “Quest Software,” the “Company,” “we,” “us,” or “our” refer to Quest Software, Inc. and its consolidated subsidiaries.

Our accompanying unaudited condensed consolidated financial statements as of June 30, 2010 and for the three and six months ended June 30, 2010 and 2009 reflect all adjustments (consisting of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the “Consolidated Financial Statements and Notes to the Consolidated Financial Statements” included in Quest’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Form 10-K”). The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period.

NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS

In October 2009, Financial Accounting Standards Board (“FASB”) issued an amendment to its accounting guidance on revenue arrangements with multiple deliverables. This new accounting guidance addresses the unit of accounting for arrangements involving multiple deliverables and how consideration should be allocated to separate units of accounting, when applicable. This guidance will be effective for fiscal years beginning on or after June 15, 2010. This guidance will not have a material impact on our consolidated financial position or results of operations.

In October 2009, FASB issued an amendment to its accounting guidance on certain revenue arrangements that include software elements. The new accounting guidance excludes from consideration of software revenue recognition principles all tangible products containing both software and non-software components that function together to deliver the product’s essential functionality. This guidance will be effective for fiscal years beginning on or after June 15, 2010. This guidance must be adopted in the same period that the company adopts the amended accounting for arrangements with multiple deliverables described in the preceding paragraph. This guidance will not have a material impact on our consolidated financial position or results of operations.

In December 2009, FASB issued new guidance regarding improvements to financial reporting by enterprises involved with variable interest entities. The new guidance provides an amendment to its consolidation guidance for variable interest entities and the definition of a variable interest entity and requires enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity. This amendment also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and is effective January 1, 2010. There was no impact from adoption of this guidance on our consolidated financial position or results of operations.

In January 2010, FASB issued an amendment to its accounting for distributions to shareholders with components of stock and cash. This new guidance clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance. This guidance is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. There was no impact from adoption of this guidance since we have never declared dividends on our common stock.

In January 2010, FASB issued an amendment to its accounting and reporting for decreases in ownership of a subsidiary. This amendment clarifies the scope of the decrease in ownership provisions in the consolidation – overall subtopic and related guidance. This amendment is effective beginning in the period that an entity adopts FASB’s guidance on Noncontrolling Interests in Consolidated Financial Statements, which was effective January 1, 2009 for us. There was no impact from the adoption of this guidance on our consolidated financial position or results of operations.

7

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

In January 2010, FASB issued an amendment regarding improving disclosures about fair value measurements. This new guidance requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. There was no impact from the adoption of this guidance to our consolidated financial position or results of operations as the amendment only addresses disclosures.

In February 2010, FASB issued an amendment to certain recognition and disclosure requirements relating to subsequent events. This amendment removes the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. Generally Accepted Accounting Principles (“GAAP”). The amendment is effective upon issuance of the final update. There was no impact from the adoption of this guidance on our consolidated financial position or results of operations as the amendment only addresses disclosures.

In March 2010, FASB issued an amendment to Derivatives and Hedging-Embedded Derivatives. The amendment provided clarifications and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception. The amendment is effective for each reporting entity at the beginning of its first fiscal quarter beginning after June 15, 2010. We do not expect adoption of this guidance to have an impact on our consolidated financial position or results of operations as we do not have contracts containing embedded credit derivative features.

In April 2010, FASB issued an amendment to Stock Compensation. The amendments clarify that an employee stock-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. We do not expect adoption of this guidance to have an impact to us since our stock-based payment awards have an exercise price denominated in the same currency of the market in which our Company shares are traded.

In July 2010, FASB issued an amendment to Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The amendments enhance disclosures about the credit quality of financing receivables and the allowance for credit losses. This Update requires an entity to provide a greater level of disaggregated information about the credit quality of its financing receivables and its allowance for credit losses. In addition, the amendments in this Update require an entity to disclose credit quality indicators, past due information, and modifications of its financing receivables. These improvements will help financial statement users assess an entity’s credit risk exposures and its allowance for credit losses. The amendment is effective for interim and annual periods ending on or after December 15, 2010. We do not expect adoption of this guidance to have an impact to us since we do not have any financing receivables.

NOTE 3 — GEOGRAPHIC AND SEGMENT REPORTING

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision maker, or decision-making group, in assessing performance and deciding how to allocate resources.

Our reportable operating segments are Licenses and Services. The Licenses segment develops and markets licenses to use our software products. The Services segment provides after-sale support for software products and fee-based training and consulting services related to our software products.

We do not separately allocate operating expenses to these segments, nor do we allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of revenues, and gross profit.

8

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Reportable segment data for the three and six months ended June 30, 2010 and 2009 is as follows (in thousands):

	Licenses		Services		Total
Three months ended June 30, 2010:
Revenues	$	77,100	$	109,002	$	186,102
Cost of revenues		5,858		15,636		21,494
Gross profit	$	71,242	$	93,366	$	164,608
Three months ended June 30, 2009:
Revenues	$	61,639	$	102,618	$	164,257
Cost of revenues		6,499		14,499		20,998
Gross profit	$	55,140	$	88,119	$	143,259
Six months ended June 30, 2010:
Revenues	$	142,081	$	215,192	$	357,273
Cost of revenues		12,172		30,360		42,532
Gross profit	$	129,909	$	184,832	$	314,741
Six months ended June 30, 2009:
Revenues	$	124,009	$	205,845	$	329,854
Cost of revenues		13,483		28,260		41,743
Gross profit	$	110,526	$	177,585	$	288,111

Revenues are attributed to geographic areas based on the location of the Quest entity from which the products or services were invoiced. Revenues and long-lived assets concerning principal geographic areas in which we operate are as follows (in thousands):

	United States		Ireland		Other International  (2)		Total
Three months ended June 30, 2010:
Revenues	$	117,248	$	22,520	$	46,334	$	186,102
Long-lived assets (1)		84,902		8		12,636		97,546
Three months ended June 30, 2009:
Revenues	$	102,916	$	15,473	$	45,868	$	164,257
Long-lived assets (1)		87,533		17		16,660		104,210
Six months ended June 30, 2010:
Revenues	$	220,291	$	43,547	$	93,435	$	357,273
Long-lived assets (1)		84,902		8		12,636		97,546
Six months ended June 30, 2009:
Revenues	$	205,747	$	29,694	$	94,413	$	329,854
Long-lived assets (1)		87,533		17		16,660		104,210

(1) Includes property and equipment, net and other assets

(2) No single location within Other International accounts for greater than 10% of total revenues

9

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

NOTE 4 — CASH AND CASH EQUIVALENTS AND INVESTMENTS

The following table summarizes our cash and cash equivalents and investments by balance sheet classification at the dates indicated (in thousands):

	June 30, 2010				December 31, 2009
	Cost		Fair Value(1)		Cost		Fair Value(1)
Cash and cash equivalents	$	316,148	$	316,148	$	292,940	$	292,940
Short-term investments		54,593		54,248		93,459		90,109
Long-term investments		68,847		68,743		2,416		2,411
Total cash and cash equivalents and investments	$	439,588	$	439,139	$	388,815	$	385,460

(1) See Note 13 – Fair Value Measurements for details regarding fair value measurements.

The following table summarizes our investments by investment category at the dates indicated (in thousands):

	June 30, 2010				December 31, 2009
Investment category:	Cost		Fair Value		Cost		Fair Value
Available-for-sale securities:
US treasury securities	$	31,499	$	31,524	$	34,982	$	34,978
US agency securities		13,142		13,166		1,500		1,495
Commercial paper		24,961		24,962		4,998		4,998
Corporate notes/bonds		42,148		42,001		—		—
Certificates/Term deposits		7,165		7,165		6,820		6,820
Total available-for-sale securities		118,915		118,818		48,300		48,291
Trading securities:
Municipal auction rate securities		4,525		4,173		47,575		44,229
Total investments	$	123,440	$	122,991	$	95,875	$	92,520

At June 30, 2010, we held $4.5 million par value (with a fair value of $4.2 million) in municipal notes with an auction reset feature (“auction rate securities” or “ARS”). These securities are collateralized long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 35 days. All of the underlying assets of our ARS were in securities collateralized by student loan portfolios, which are guaranteed by the United States government. In October 2008, we entered into agreements (the “Agreements”) with the investment firm that sold us our ARS. By entering into the Agreements, we (1) received the right (“Put Options”) to sell all of our ARS back to the investment firm at par, at our sole discretion, anytime during the period from June 30, 2010 through July 2, 2012, (2) gave the investment firm the right to purchase all of our ARS or sell them on our behalf at par anytime after the execution of the Agreements through July 2, 2012, (3) received an offer for a “no net cost” loan for up to 70% of the par value of the ARS until June 30, 2010, and (4) agreed to release the investment firm from certain potential claims related to the collateralized ARS in certain specified circumstances. We estimated the fair values of the ARS we held at June 30, 2010 based on a discounted cash flow model and we elected to measure the Put Options under the fair value option. Refer to Note 13 – Fair Value Measurements for further details.

We redeemed approximately $40.6 million and $43.0 million par value of our ARS during the three months and six months ended June 30, 2010, respectively. We exercised our Put Options on July 1, 2010 under the Agreements, and redeemed our remaining ARS of $4.5 million par value. Refer to Note 16 – Subsequent Events for further details.

10

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

NOTE 5 — LOANS PAYABLE

In February 2009, we entered into a two year revolving line of credit agreement with Wells Fargo Foothill, LLC as the arranger, administrative agent and lender. We intend to use any proceeds from the credit agreement for working capital and other general corporate purposes. The credit agreement allows for cash borrowings and letters of credit under a secured revolving credit facility of up to a maximum of $100 million. Interest will accrue at a floating rate based on, at the Company’s election, (i) LIBOR (subject to reserve requirements and a minimum LIBOR of 2.75%) or (ii) the greatest of (a) 4.0%, (b) the Federal Funds Rate plus 0.5% or (c) Wells Fargo’s prime rate, in each case, plus an applicable margin. The credit agreement includes limitations on the Company’s ability to, among other things, incur debt, grant liens, make acquisitions and other investments, make certain restricted payments such as dividend payments, and dispose of assets. The credit agreement is secured by substantially all of the Company’s assets, subject to certain exceptions including the Company headquarters facility, and includes certain financial covenants. Total fees associated with this line of credit were approximately $2.0 million and will be amortized over the life of the credit agreement as interest expense. For the three and six months ended June 30, 2010, $0.2 million and $0.5 million, respectively, in amortization of these fees was recognized as interest expense within other (expense) income, net. As of June 30, 2010, we have a zero balance outstanding under this line of credit.

In July 2009, we drew down $34.4 million, or 70%, of the par value against the value of our ARS. The ARS were pledged as collateral for the amount drawn on our UBS Financial Services line of credit. As this credit line was structured as a “net no cost” loan, any interest charges will be offset by interest earned on the underlying ARS. See Note 4 – Cash and Cash Equivalents and Investments for additional details regarding these investments. During the quarter ended June 30, 2010, we redeemed approximately $40.6 million of our auction rate securities, a portion of such redemption paid in full our $29.6 million balance outstanding on our UBS line of credit.

In August 2009, we entered into a loan agreement with Mutual of Omaha Bank whereby we borrowed an aggregate principal amount of $34 million. The loan is secured by our real property at our headquarters in Aliso Viejo, California. We intend to use the proceeds from the loan for working capital and other general corporate purposes. The loan matures in five years, during which time we will make equal monthly principal and interest payments at a 7.03% interest rate on a fixed rate, 25-year amortization schedule. Events of default include, among other things, payment defaults, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lender may, among other things, accelerate the payment of any unpaid principal and interest amounts, increase the then-current interest rate by 5% and foreclose on the real estate collateral. As of June 30, 2010, we have a $33.6 million balance outstanding with $0.6 million recorded as current and $33.0 million recorded as long-term portion of loans payable.

We were in compliance with all debt-related covenants at June 30, 2010.

NOTE 6 — OTHER (EXPENSE) INCOME, NET

Other (expense) income, net consists of the following (in thousands):

	Three Months Ended June  30						Six Months Ended June  30
	2010			2009			2010			2009
Interest income	$	532		$	487		$	844		$	1,194
Interest expense		(1,108	)		(495	)		(2,238	)		(725	)
Foreign currency (losses) gains, net (1)		(4,671	)		5,396			(8,853	)		986
Forward foreign currency contracts gains (losses), net (2)		1,411			(799	)		2,506			(1,408	)
Unrealized gains (losses) on ARS (3)		2,456			(605	)		2,970			5,778
Unrealized (losses) gains on Put Options (3)		(2,458	)		733			(2,978	)		(5,376	)
Other (expense) income, net		(5	)		63			300			185
Total other (expense) income, net	$	(3,843	)	$	4,780		$	(7,449	)	$	634

(1) Our foreign currency (losses) gains, net are predominantly attributable to translation gains or losses on the re-measurement of our net balances of monetary assets and liabilities in our foreign subsidiaries, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. The foreign currency translation adjustments to these balance sheet items are calculated by comparing the currency spot rates at the end of a month to the spot rates at the end of the previous month.

11

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

(2) Relates to changes in fair value of our forward foreign currency contracts not designated as hedging instruments. See Note 12 — Derivative Instruments for further details.

(3) See Note 4 — Cash and Cash Equivalents and Investments for details.

NOTE 7 — INCOME TAX PROVISION

During the three and six months ended June 30, 2010, the provision for income taxes increased to $11.8 million and $16.4 million, respectively from $5.6 million and $10.3 million in the comparable period in 2009. The effective income tax rate for the three and six months ended June 30, 2010 was approximately 40.3% and 33.1%, respectively from 21.6% and 25.2% in the comparable period of 2009. The increase is primarily a result of the mix of pre-tax income between high and low tax jurisdictions, and other discrete items impacting the quarter ended June 30, 2010. Discrete items included an increase to income tax provision relating to the write-off of deferred tax assets associated with cancelled, forfeited and expired stock options recorded during the three months ended June 30, 2010, and adjustments related to our adoption of FASB’s new accounting guidance on business combinations and enactment of California legislation during the period.

NOTE 8 — NET INCOME PER SHARE

Basic net income per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and restricted stock units, in the weighted-average number of common shares outstanding for a period, if dilutive.

The table below sets forth the reconciliation of the denominator of the net income per share calculation (in thousands):

	Three Months Ended June  30		Six Months Ended June  30
	2010	2009	2010	2009
Shares used in computing basic net income per share	89,434	94,381	89,548	94,355
Dilutive effect of stock options and restricted stock units (1)	2,486	1,748	2,587	1,623
Shares used in computing diluted net income per share	91,920	96,129	92,135	95,978

(1) Options to purchase 5.8 million and 9.2 million shares of common stock were outstanding during the three months ended June 30, 2010 and 2009, respectively, and 5.5 million and 9.4 million shares of common stock during the six months ended June 30, 2010 and 2009, respectively, were outstanding but were not included in the computation of diluted net income per share as inclusion would have been anti-dilutive.

NOTE 9 — STOCK-BASED COMPENSATION

We offer stock-based awards to employees, directors and consultants under the Quest Software, Inc. 2008 Stock Incentive Plan (the “2008 Plan”). The 2008 Plan was adopted by our Board of Directors as a means to secure and retain the services of our employees, directors, and consultants, to provide such eligible individuals an opportunity to benefit from increases in the value of our Common Stock through the grant of stock awards, and thereby align the long-term compensation and interests of those individuals with our stockholders.

The 2008 Plan provides for the discretionary grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, and other forms of equity compensation (collectively, the “stock awards”). The number of shares of Common Stock available for issuance under the 2008 Plan is 25.7 million as of June 30, 2010. The number of shares of Common Stock reserved for issuance under the 2008 Plan will be reduced by 1 share for each share of Common Stock issued under the 2008 Plan pursuant to a stock option and by 1.94 shares for each share of Common Stock issued under the 2008 Plan pursuant to a restricted stock award, restricted stock unit award, or other stock award. As of June 30, 2010, there were 12.2 million shares available for grant under the 2008 Plan.

12

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Stock Option Awards

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The fair value of these awards is amortized on a straight-line basis over the vesting period. Expected volatilities are based on historical volatilities of Quest’s stock. We use historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate is based on the U.S. Treasury zero-coupon issues in effect at the time of option grant for equivalent remaining terms. We do not expect to pay any dividends and, therefore, we use an expected dividend yield of zero.

We used the following weighted-average assumptions for option awards granted during the three months and six months ended June 30, 2010 and 2009:

	Three Months Ended June  30			Six Months Ended June  30
	2010 (1)	2009		2010		2009
Expected volatility	N/A	40	%	37	%	40	%
Expected term (in years)	N/A	5.9		6.4		5.9
Risk-free interest rate	N/A	2.4	%	2.8	%	2.2	%
Expected dividend yield	None	None		None		None

(1) There were no option awards granted for the three months ended June 30, 2010.

A summary of the activity of employee stock options during the six months ended June 30, 2010, and details regarding the options outstanding and exercisable at June 30, 2010, are provided below:

	Number of Shares (in thousands)		Weighted-Average Exercise  Price (per share)		Weighted-Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)  (1)
Outstanding at December 31, 2009	13,400		$	16.77
Granted	2,182		$	16.59
Exercised	(1,813	)	$	12.85
Canceled/forfeited/expired	(870	)	$	29.72
Outstanding at June 30, 2010	12,899		$	16.41	5.21	$	43,398
Vested or expected to vest at June 30, 2010	12,288		$	16.41	4.99	$	42,524
Exercisable at June 30, 2010	8,359		$	16.48	3.06	$	35,428

(1) These amounts represent the difference between the exercise price and $18.04, the closing price of Quest Software, Inc. stock on June 30, 2010 as reported on the NASDAQ National Market, for all options outstanding that have an exercise price currently below the closing price.

The weighted-average fair value of options granted during the six months ended June 30, 2010 and 2009 was $6.98 and $5.18, respectively. The total intrinsic value of options exercised was $10.5 million and $1.5 million for the six months ended June 30, 2010 and 2009, respectively. The total fair value of options vested during the six months ended June 30, 2010 and 2009 was $4.1 million and $5.0 million, respectively.

Restricted Stock Unit Awards (“RSU Awards”)

RSU awards have been granted to selected executives pursuant to our Executive Incentive Plan. We have also granted RSU awards to key employees pursuant to the Managing For Results Profit Sharing Plan. All of our outstanding RSU awards vest over three years with vesting contingent upon continuous service and meeting certain company-wide performance goals, including sales, operating profit margin, and cash flow targets. We estimate the fair value of RSU awards using the market price of our common stock on the date of the grant. The fair value of these awards is amortized on a straight-line basis over the vesting period.

13

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

A summary of our RSU awards activity during the six months ended June 30, 2010 is provided below:

	Number of Shares		Weighted-Average Grant  Date Fair Value (per share)
Nonvested at January 1, 2010	713,449		$	12.79
Granted	716,507		$	16.68
Vested	(366,222	)	$	14.22
Forfeited	(33,650	)	$	12.49
Nonvested at June 30, 2010	1,030,084		$	15.00

The total fair value of RSU awards vested during the six months ended June 30, 2010 and 2009 was $5.2 million and $2.9 million, respectively.

Stock-Based Compensation Expense

The following table presents the income statement classification of all stock-based compensation expense for the three months and six months ended June 30, 2010 and 2009 (in thousands):

	Three Months Ended June  30				Six Months Ended June  30
	2010		2009		2010		2009
Cost of services	$	199	$	176	$	383	$	336
Sales and marketing		1,246		1,459		2,359		2,721
Research and development		1,592		1,146		3,010		2,600
General and administrative		1,478		417		3,418		1,674
Total stock-based compensation		4,515		3,198		9,170		7,331
Tax benefit associated with stock-based compensation expense (1)		1,747		691		3,549		1,850
Reduction of net income	$	2,768	$	2,507	$	5,621	$	5,481

(1) The recognized tax benefit related to share-based compensation expense is estimated to be 38.7% and 40.0% for the three months ended June 30, 2010 and 2009, respectively, and 38.7% and 40.0% for the six months ended June 30, 2010 and 2009, respectively. This approximates the blended Federal and State statutory tax rate after the benefit for state taxes.

As of June 30, 2010, total unrecognized stock-based compensation cost related to unvested stock option awards was $23.5 million, which is expected to be recognized over a weighted-average period of 4.3 years and total unrecognized stock-based compensation cost related to unvested RSU awards was $13.4 million, which is expected to be recognized over a weighted-average period of 2.1 years.

NOTE 10 — STOCKHOLDERS’ EQUITY

On August 9, 2009, the Board of Directors authorized a plan to repurchase up to $100 million of Quest’s common stock. Any stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice. During the quarter ended June 30, 2010, we repurchased 0.3 million shares under this plan at a weighted average price per share of $16.67 for a total cost of $5.3 million.

14

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

NOTE 11 — RELATED PARTY TRANSACTIONS

In 2000, we received a note receivable with a face amount of $15.8 million from one of our then executive officers for the purchase of 339,200 shares of our common stock at a purchase price of $46.50 per share. The officer granted Quest a security interest in the shares and also assigned, transferred, and pledged the shares to Quest to secure his obligations under the note. The Company maintains physical possession of the certificates representing the shares purchased as collateral until payment of the principal and interest under the note is made. As the note receivable is deemed to be a non-recourse obligation, the transaction was treated as a stock option for financial reporting purposes. The former officer remained employed by Quest as of June 30, 2010. The original maturity date of the note receivable was August 2007. In December 2009, the former executive officer and Quest signed a letter extending the due date of the note receivable until June 1, 2010. The note receivable is due and we are currently pursuing methods of collection or other means of recovery.

NOTE 12 — DERIVATIVE INSTRUMENTS

Foreign Exchange Risk Management Policy

Our Foreign Exchange Risk Management Policy identifies target exposures such as balance sheet, cash flow and income statement risks, program objectives, approved financial instruments and counterparties, accounting and tax treatment, as well as oversight, reporting and controls. The functional currency of all our subsidiaries is the U.S. Dollar. Our exposure to foreign exchange risk originates both from the operating results of our foreign operations denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities within our foreign subsidiaries. These exposures have the potential to produce either gains or losses depending on the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Certain balance sheet items are re-measured each period and the changes in value are recorded within other (expense) income, net.

We utilize a limited balance sheet hedging program with the stated objective of reducing volatility within other (expense) income, net. Under this program, we use derivatives in the form of forward foreign currency contracts to hedge certain balance sheet exposures. We do not designate these contracts as hedging instruments and therefore do not require hedge accounting. Accordingly, these outstanding non-designated derivatives are recognized on the condensed consolidated balance sheet at fair value and the changes in fair value from these contracts are recorded in other (expense) income, net, in the condensed consolidated income statement. These derivative contracts typically have a one month term.

We have a limited cash flow hedging program primarily focused on reducing volatility in our forecasted research and development cash expenses and license revenues; some of which are denominated in non-U.S. Dollar currencies. Under this program, we use derivatives in the form of forward foreign currency contracts to hedge certain forecasted transactions. These derivatives are designated as hedging instruments, with durations ranging from less than one month to nine months, and therefore we elect hedge accounting. Accordingly, these outstanding designated derivatives are recognized on the condensed consolidated balance sheet at fair value. Changes in value that are highly effective are recognized in Accumulated other comprehensive income (“AOCI”) on the condensed consolidated balance sheets, until the hedged item is recognized in the income statement. Any ineffective portion of a derivative’s change in fair value is recorded in other (expense) income, net, in the condensed consolidated income statement. There was no material ineffectiveness in our cash flow hedging program for the six months ended June 30, 2010.

During the quarter ended June 30, 2010, we entered into approximately $18.3 million in foreign currency hedges for our anticipated acquisition of Völcker in July 2010 (refer to Note 16 – Subsequent Events for further details). We do not designate these types of contracts as hedging instruments. Accordingly, these outstanding non-designated derivatives are recognized on the condensed consolidated balance sheet at fair value and the changes in fair value from these contracts are recorded in other (expense) income, net, in the condensed consolidated income statement.

15

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

We had the following notional amounts for our forward foreign currency contracts included in our condensed consolidated balance sheets (in U.S. Dollars in thousands):

Currency	June 30 2010		December  31 2009
Derivatives designated as hedging instruments
Australian Dollar	$	2,244	$	2,545
Canadian Dollar		8,482		11,554
Israeli Shekel		2,055		1,947
Russian Ruble		5,828		5,586
British Pound		8,702		—
Euro		16,593		6,440
Total	$	43,904	$	28,072
Derivatives not designated as hedging instruments
Danish Krone	$	986	$	1,214
Norwegian Krone		614		—
Swedish Krona		257		—
Euro		36,647		15,551
Australian Dollar		1,674		—
Brazil Real		3,294		—
British Pound		10,446		9,965
Total	$	53,918	$	26,730

Fair Value of Derivative Instruments

The following table provides the fair value of our forward foreign currency contracts included in our condensed consolidated balance sheets (in thousands):

Derivative Assets

Derivative Liabilities

June 30, 2010

December 31, 2009

June 30, 2010

December 31, 2009

Derivatives designated as hedging instruments

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Forward foreign currency contracts

Prepaid expenses and other current assets

$

892

Prepaid expenses and other current assets

$

284

Other accrued expenses

$

579

Other accrued expenses

$

—

Derivative Assets

Derivative Liabilities

June 30, 2010

December 31, 2009

June 30, 2010

December 31, 2009

Derivatives not designated as hedging instruments

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Balance Sheet Location

Fair Value(1)

Forward foreign currency contracts

Prepaid expenses and other current assets

$

362

Prepaid expenses and other current assets

$

836

Other accrued expenses

$

541

Other accrued expenses

$

—

(1) See Note 13 – Fair Value Measurements for details.

16

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The Effect of Derivative Instruments on Financial Performance

The following tables provide the effect derivative instruments had on our AOCI and results of operations (in thousands):

	Three Months Ended June 30
Derivatives designated as hedging instruments	Amount of loss recognized in AOCI (effective portion)				Location of gain reclassified from accumulated AOCI into income statement (effective portion)	Amount of gain reclassified from accumulated AOCI (effective portion)
	2010		2009			2010		2009
Forward foreign currency contracts	$	388	$	—	Revenues	$	554	$	—
					Operating expenses	$	62	$	—
	Six Months Ended June 30
Derivatives designated as hedging instruments	Amount of gain recognized in AOCI (effective portion)				Location of gain reclassified from accumulated AOCI into income statement (effective portion)	Amount of gain reclassified from accumulated AOCI (effective portion)
	2010		2009			2010		2009
Forward foreign currency contracts	$	51	$	—	Revenues	$	686	$	—
					Operating expenses	$	384	$	—

	Three Months Ended June 30
Derivatives not designated as hedging instruments	Location of gain (loss) recognized on derivative instruments	Amount of gain (loss) recognized on derivative instruments
		2010		2009
Forward foreign currency contracts	Other (expense) income, net	$	1,411	$	(799	)
	Six Months Ended June 30
Derivatives not designated as hedging instruments	Location of gain (loss) recognized on derivative instruments	Amount of gain (loss) recognized on derivative instruments
		2010		2009
Forward foreign currency contracts	Other (expense) income, net	$	2,506	$	(1,408	)

NOTE 13 — FAIR VALUE MEASUREMENTS

We perform fair value measurements in accordance with FASB’s guidance on Fair Value Measurements and Disclosures. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies under other accounting pronouncements that require or permit fair value measurements. The standard discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

• Level 1: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

• Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

• Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions when there is little or no market data.

17

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

We measure our financial assets and liabilities at fair value on a recurring basis using the following valuation techniques:

(a) Market Approach – uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

(b) Income Approach – uses valuation techniques to convert future estimated cash flows to a single present amount based on current market expectations about those future amounts, using present value techniques.

The following table represents our fair value hierarchy and the valuation techniques used for financial assets and financial liabilities measured at fair value on a recurring basis (in thousands):

	June 30, 2010
	Total		Level 1		Level 2		Level 3			Valuation Techniques
Assets:
Money market funds	$	235,312	$	235,312	$	—	$	—		(a	)
U.S. treasury securities		31,524		31,524		—		—		(a	)
U.S. agency securities		13,166		13,166		—		—		(a	)
Corporate notes/bonds		42,001		42,001		—		—		(a	)
Certificates of deposit		8,492		8,492		—		—		(a	)
Commercial paper		39,952		39,952		—		—		(a	)
ARS (1)		4,173		—		—		4,173		(b	)
Put Options (1)		352		—		—		352		(b	)
Derivative assets ( 2)		1,254		—		1,254		—		(a	)
Total	$	376,226	$	370,447	$	1,254	$	4,525
Level 3 as % of total								1.2	%
Liabilities:
Derivative liabilities ( 2)		1,120		—		1,120		—		(a	)
Contingent consideration ( 3)		4,000		—		—		4,000		(b	)
Total	$	5,120	$	—	$	1,120	$	4,000
	December 31, 2009
	Total		Level 1		Level 2		Level 3			Valuation Techniques
Assets:
Money market funds	$	178,303	$	178,303	$	—	$	—		(a	)
U.S. treasury securities		55,371		55,371		—		—		(a	)
U.S. agency securities		1,495		1,495		—		—		(a	)
Certificates of deposit		8,598		8,598		—		—		(a	)
Commercial paper		29,991		29,991		—		—		(a	)
ARS (1)		44,229		—		—		44,229		(b	)
Put Options (1)		3,330		—		—		3,330		(b	)
Derivative assets ( 2)		1,120		—		1,120		—		(a	)
Total	$	322,437	$	273,758	$	1,120	$	47,559
Level 3 as % of total								14.7	%
Liability:
Contingent consideration (3)	$	4,000	$	—	$	—	$	4,000		(b	)

18

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

(1) See Note 4 — Cash and Cash Equivalents and Investments for details.

(2) See Note 12 – Derivative Instruments for details.

(3) Relates to acquisition of PacketTrap in 2009. $2.0 million was recorded in Other accrued expenses and the remainder was recorded in Other long-term liabilities on our condensed consolidated balance sheets both as of June 30, 2010 and December 31, 2009.

As of June 30, 2010, we held certain assets that are required to be measured at fair value on a recurring basis. These assets included cash equivalents and investments. Included in our investments at June 30, 2010 was $4.5 million par value (with a fair value of $4.2 million) in ARS. We exercised our Put Options on July 1, 2010 under the Rights Agreement, and redeemed our remaining ARS of $4.5 million par value. Refer to Note 16 – Subsequent Events for further details. We estimated the fair values of the ARS and related Put Options we held at June 30, 2010 based on a discounted cash flow model that we prepared. Key considerations to our discounted cash flow model included, among other items, the general climate of interest rates, the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security is expected to have a successful auction. Using our discounted cash flow model we determined that the fair values of the ARS we held at June 30, 2010 were less than par.

The following table presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2010 and 2009 (in thousands):

	Six Months Ended June 30
	2010			2009
Total, beginning of the period	$	47,559		$	49,283
Unrealized gains on ARS included within other (expense) income, net		2,970			5,779
Unrealized losses on put options included within other (expense) income, net		(2,978	)		(5,377	)
Sale of ARS (par value)		(43,026	)		(125	)
Total, end of the period	$	4,525		$	49,560

Other Financial Assets and Liabilities

The carrying amounts of our other financial assets and liabilities including accounts receivable, accounts payable and accrued liabilities approximate their respective fair values because of the relatively short period of time between their origination and their expected realization.

The book value and fair value of our current and long-term portion of loans payable as of June 30, 2010 are as follows (in thousands):

	Book Value		Fair Value (1)
Current portion of loans payable	$	543	$	543
Long-term portion of loans payable		33,012		33,012
	$	33,555	$	33,555

(1) Estimated fair value of long-term debt is based on quoted prices for similar liabilities for which significant inputs are observable.

19

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

NOTE 14 — GOODWILL AND INTANGIBLE ASSETS, NET

The changes in the carrying amount of goodwill by reportable operating segment for the six months ended June 30, 2010 are as follows (in thousands):

	Licenses		Services		Total
Balance as of December 31, 2009	$	470,934	$	199,547		670,481
Acquisitions (1)		—		—		—
Adjustments (2)		464		283		747
Balance as of June 30, 2010	$	471,398	$	199,830	$	671,228

(1) No acquisitions for the six months ended June 30, 2010

(2) Primarily from post-acquisition payment obligations to former shareholders of acquisitions we made in 2007 in pursuant to accounting principles applicable to acquisitions in that year.

Intangible assets, net are comprised of the following (in thousands):

	June 30, 2010							December 31, 2009
	Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Acquired technology and IPR&D (1)	$	154,347	$	(125,904	)	$	28,443	$	154,247	$	(117,424	)	$	36,823
Customer relationships		69,677		(44,796	)		24,881		69,577		(39,438	)		30,139
Non-compete agreements		13,919		(12,752	)		1,167		13,919		(12,176	)		1,743
Trademarks and trade names (2)		13,300		(6,095	)		7,205		13,080		(5,713	)		7,367
	$	251,243	$	(189,547	)	$	61,696	$	250,823	$	(174,751	)	$	76,072

(1) With our 2009 acquisition of PacketTrap, one IPR&D project was identified and valued. This project will be assessed for impairment when completed. Upon completion, the project will be amortized over its estimated useful life.

(2) Trademarks and trade names include $6.2 million and $0.8 in trade names related to our acquisition of ScriptLogic and PacketTrap, respectively, that each have an indefinite useful life, and as such are not being amortized.

Amortization expense for amortizing intangible assets was $7.1 million and $14.8 million for the three and six months ended June 30, 2010, respectively. This compares to $7.9 million and $16.6 million for the three and six months ended June 30, 2009, respectively.

Estimated annual amortization expense related to amortizing intangible assets reflected on our June 30, 2010 condensed consolidated balance sheet is as follows (in thousands):

	Estimated Annual Amortization Expense
2010 (remaining 2 quarters)	$	12,506
2011		23,402
2012		15,776
2013		2,514
2014 and thereafter		498
Total accumulated amortization	$	54,696

20

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

NOTE 15 — COMMITMENTS AND CONTINGENCIES

Securities Litigation. In October 2006, a purported shareholder class action was filed in the United States District Court for the Central District of California against Quest and certain of its current or former officers and directors (the “Options Class Action”). The plaintiff alleged that (i) the Company improperly backdated stock options, resulting in false or misleading disclosures concerning, among other things, Quest’s financial condition and (ii) the individual defendants sold Quest stock while in possession of material nonpublic information resulting in damages to the putative plaintiff class, in violation of Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.

Pursuant to a Stipulation and Agreement of Settlement entered into on November 6, 2009, the Company, the class representative and certain current and former officers and directors of the Company agreed to settle the Options Class Action for a payment of $29.4 million. On December 7, 2009, the U.S. District Court preliminarily approved the settlement. Shortly thereafter, the Company funded its share, $19.0 million, of the $29.4 million settlement, with the remainder being funded directly by the Company’s liability insurance carriers. No class members opted out of or objected to the settlement prior to the February 15, 2010 deadline for doing so. In a final hearing before the U.S. District Court on April 26, 2010, the U.S. District Court entered a judgment dismissing the Options Class Action with prejudice as to all defendants, including the Company. None of the Plaintiffs included in the class appealed the judgment, and the judgment is now final.

We have indemnification agreements with present and former directors and officers under which we are generally required to indemnify them against expenses, including attorney’s fees, judgments, fines and settlements, arising from the foregoing legal proceedings and investigations (subject to certain exceptions, including liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest or results in improper personal benefit). The Company is currently paying or reimbursing legal expenses being incurred in connection with these matters by a number of its current and former directors and officers. The maximum potential amount of the future payments we could be required to make under these indemnification obligations could be significant.

General. The Company and its subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The foregoing discussion includes material developments that occurred during the three months ended June 30, 2010 or thereafter in our material legal proceedings.

In the normal course of our business, we enter into certain types of agreements that require us to indemnify or guarantee the obligations of other parties. These commitments include (i) intellectual property indemnities to licensees of our software products, (ii) indemnities to certain lessors under office space leases for certain claims arising from our use or occupancy of the related premises, or for the obligations of our subsidiaries under leasing arrangements, (iii) indemnities to customers, vendors and service providers for claims based on negligence or willful misconduct of our employees and agents, (iv) indemnities to our directors and officers to the maximum extent permitted under applicable law, and (v) letters of credit and similar obligations as a form of credit support for our international subsidiaries and certain resellers. The terms and duration of these commitments varies and, in some cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make there under; accordingly, our actual aggregate maximum exposure related to these types of commitments cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for obligations of this nature, and no liabilities have been recorded for these obligations in our financial statements included in this report.

NOTE 16 — SUBSEQUENT EVENTS

We held $4.5 million par value ARS at June 30, 2010. We exercised our Put Options on July 1, 2010 under the Agreements, and the investment firm transferred our remaining ARS of $4.5 million par value out of our account and replaced with cash, fulfilling their obligation under the Agreements and reducing our auction rate securities to zero.

In July 2010, we acquired 100% voting equity interest of Germany-based Völcker Informatik AG, a privately held identity management solutions provider for cash consideration of approximately €16 million. The acquisition further extends the Quest^® One Identity Solution product portfolio. In connection with the acquisition, Quest also agreed to certain post-closing payments with a maximum potential payout of approximately €4 million paid over three years. Also, in July 2010 we signed a definitive agreement to acquire Surgient, Inc., a privately held company. We anticipate that this acquisition will close during the third quarter of 2010. These acquisitions will be accounted for as business combinations and the purchase price is expected to be allocated primarily to goodwill and other intangible assets. The effect of these transactions were not material to our consolidated results.

21

QUEST SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

At June 30, 2010, we had $2.0 million in notes receivable from a cost method investee included in Other assets in our condensed consolidated balance sheet. The loan bore interest on the outstanding principal amount at the rate of 10% per annum. The note was due and payable on November 1, 2011. In August 2010, the principal amount plus all accrued interest under the notes receivable was converted into equity and reclassified to cost method investments.

22

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations (“MD&A”) should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Report. Certain statements in this Report, including statements regarding our business strategies, operations, financial condition and prospects are forward-looking statements. Use of the words “believe,” “expect,” “anticipate,” “will,” “contemplate,” “would,” “project,” “plan,” “may,” “could,” “intend,” “likely,” “might,” “estimate,” “continue” and similar expressions that contemplate future events may identify forward-looking statements.

Numerous important factors, risks and uncertainties affect our operations and could cause actual results to differ materially from those expressed or implied by these or any other forward-looking statements made by us or on our behalf. Readers are urged to carefully review and consider the various disclosures made in this Report, including those described under Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009, and in other filings with the SEC that attempt to advise interested parties of certain risks and factors that may affect our business, which are available on the SEC’s website at www.sec.gov. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management’s opinions only as of the date thereof. We do not assume any obligation to revise or update forward-looking statements. Finally, our historic results should not be viewed as indicative of future performance.

We have trademarks and registered trademarks in the United States and other countries, including Quest, Quest Software, the Quest Software logo, AccessManager, ActiveDL, ActiveGroups, ActiveRoles, Benchmark Factory, Big Brother, BridgeAccess, BridgeAutoEscalate, BridgeSearch, BridgeTrak, ChangeAuditor, ChangeManager, CI Discovery, Defender, Desktop Authority, Directory Analyzer, DS Analyzer, DS Expert, Enterprise Security Reporter, File System Auditor, Foglight, GPOADmin, Help Desk Authority, InstantAssist, IntelliProfile, InTrust, iToken, JClass, JProbe, LiteSpeed, LiveReorg, LogADmin, MessageStats, NBSpool, NetBase, PacketTrap, PassGo, PerformaSure, Point, Click, Done!, PowerGUI, Privilege Authority, ReportADmin, RestoreADmin, ScriptLogic, Secure Copy, Security Explorer, Security Lifecycle Map, SelfServiceADmin, SharePlex, Spotlight, SQL Navigator, Stat, StealthCollect, Tag and Follow, Toad, T.O.A.D., Toad World, vConverter, vEcoShell, VESI, vFoglight, Vizioncore, Vizioncore vAutomation, Vizioncore vEssentials, vRanger, vSpotlight, vToad, WebDefender, and XRT. Other trademarks and registered trademarks are the property of their respective owners.

Overview

Our Company and Business Model

Quest Software, Inc., together with our subsidiaries ScriptLogic and Vizioncore, delivers innovative products that help IT organizations get enhanced performance from their computing environment. Our product areas are Application Management, Database Management, Windows Management and Virtualization Management. The focus of our products is based upon generating higher levels of performance, manageability and productivity throughout our customers’ IT infrastructure with products and services that enable them to manage the investments they have made within their IT environment.

Quarterly Update

As discussed in more detail throughout our MD&A, for the three months ended June 30, 2010 compared to the three months ended June 30, 2009, we delivered the following financial performance:

• Total revenues increased by $21.8 million, or 13.3%, to $186.1 million while license revenues grew 25.1% to $77.1 million.

• Total expenses increased by $10.2 million, or 7.1%, to $153.1 million.

• Income from operations increased by $11.6 million, or 54.8%, to $33.0 million.

• Diluted earnings per share decreased by $0.02, or 9.5%, to $0.19.

23

Our second quarter 2010 total revenues increased by 13.3% while our license revenues grew 25.1% as our Americas sales region, which includes United States, Canada and Latin America, and our Asia Pacific (“APAC”) sales region showed improvement. Our EMEA sales region, which includes Europe, the Middle East and Africa, that delivered a solid growth in the first quarter of 2010, was affected by the economic conditions faced by Greece. The uncertainties brought about by the global recession, which impacted information technology spending, remained but to a lesser extent compared to the same period in 2009. Our Americas sales region contributed 66.0% of total revenues and the rest of the world contributed 34.0% of total revenues in the quarter as compared to 65.3% and 34.7% in the comparable quarter last year.

Along product lines, the increase in our total revenues was primarily driven by increased sales of our Windows Management products, particularly our Migration, Identity Management and ScriptLogic desktop solutions, and related professional services across all sales regions. We expect this trend to continue in our Windows Management products due to our customers’ migration to Microsoft Exchange Server 2010, which was launched in November 2009, Windows Server 2008 R2, which was launched in October 2009 and SharePoint 2010, which was launched in May 2010. In addition, we acquired Völcker in July 2010 (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for further details) giving us access to a larger aspect of the Identity Access Management market and the continued expansion of our Identity Management solution capabilities. Revenues from our Virtualization Management increased by approximately 24.5% compared to the same period in 2009. We expect this trend to continue as companies embrace virtual computing because of the associated cost savings. We are well positioned to capitalize on this major growth trend as we offer flexible solutions for managing virtualized IT infrastructure. Also, in July 2010 we signed a definitive agreement to acquire Surgient (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for further details), which we anticipate will add private cloud management capabilities to our virtualization product portfolio. Revenues from our other product areas were comparable to the same period in 2009.

Total revenues were positively impacted by the weakening U.S. Dollar relative to certain non-U.S. Dollar currencies, including the Australian Dollar, Canadian Dollar and Russian Ruble. This was partially offset by an appreciating U.S. Dollar in the latter part of the second quarter relative to the Euro and British Pound. Since certain of our international sales are denominated in non-U.S. Dollar currencies, the impact from foreign currency resulted in higher US dollar equivalent sales of approximately $1.6 million of the overall increase in total revenues.

Total expenses increased compared to the same period in 2009. Our expenses primarily consist of personnel costs, which include compensation, benefits and payroll related taxes and are primarily a function of our worldwide headcount. Our average full-time employee headcount for the second quarter of 2010 was 3,256, a decrease of 227 compared to 3,483 for the second quarter of 2009. Our average full-time employee headcount in locations outside of the United States was 1,497 for the second quarter of 2010, a decrease of 142 compared to 1,639 for the second quarter of 2009. Our second quarter 2010 total expenses were impacted by the weakening U.S. Dollar relative to certain non-U.S. Dollar currencies partially offset by an appreciating U.S. Dollar relative to the Euro and British Pound, as discussed above. This resulted in higher U.S. Dollar equivalent expenses for several currencies as noted above. Since certain of our international expenses are denominated in non-U.S. Dollar currencies, our total expenses in the second quarter of 2010 increased by $3.6 million compared to the same period in 2009 as a result of the impact of foreign currency exchange rates when comparing 2010 rates to 2009, or approximately 35.8% of the overall increase in total expenses. The remaining increase in total expenses was primarily due to the increase in sales and marketing expenses, $3.5 million of which was due to higher sales commissions as a result of higher revenue compared to the second quarter of 2009.

Foreign Currency

While we are a U.S. Dollar functional company on a world-wide basis, we transact business and operate using multiple foreign currencies. As such, the value of our revenues, expenses, certain account balances and cash flows are exposed to fluctuations in foreign currencies against the value of the U.S. Dollar. For example, when the U.S. Dollar strengthens against several non-U.S. Dollar currencies, our foreign revenues and thus our total revenues can be negatively impacted. Similarly, a stronger U.S. Dollar translates into lower expenses in those entities where we have operations and our personnel and occupancy expenses are denominated in non-U.S. Dollars. Thus our total expenses would be lower. Conversely, a weaker U.S. Dollar would have the opposite effect on total revenues and expenses all other things being equal. In certain geographic regions and within specific currencies, there are partial offsets between revenues and expenses or balance sheet positions that may reduce this exposure. In other instances, we can manage our operations to reduce foreign currency exposure or utilize forward foreign currency contracts to manage this exposure.

24

Results of Operations

The following are percentage of total revenues:

	Three Months Ended June 30				Six Months Ended June  30
	2010		2009		2010		2009
Revenues:
Licenses	41.4	%	37.5	%	39.8	%	37.6	%
Services	58.6		62.5		60.2		62.4
Total revenues	100.00		100.0		100.00		100.00
Cost of revenues:
Licenses	1.0		1.1		1.0		1.1
Services	8.4		8.8		8.5		8.6
Amortization of purchased technology	2.1		2.8		2.4		3.0
Total cost of revenues	11.5		12.7		11.9		12.7
Gross profit	88.5		87.3		88.1		87.3
Operating expenses:
Sales and marketing	38.8		39.9		39.3		40.0
Research and development	19.6		21.6		20.1		22.2
General and administrative	10.7		10.8		11.0		11.0
Amortization of other purchased intangible assets	1.7		2.0		1.8		2.0
Total operating expenses	70.8		74.3		72.2		75.2
Income from operations	17.7		13.0		15.9		12.1
Other (expense) income, net	(2.1	)	2.9		(2.1	)	0.2
Income before income tax provision	15.6		15.9		13.8		12.3
Income tax provision	6.3		3.4		4.6		3.1
Net income	9.3	%	12.5	%	9.2	%	9.2	%

Comparison of Three Months Ended June 30, 2010 and 2009

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

	Three Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars		Percentage
Revenues:
Licenses
Americas	$	49,701	$	38,576	$	11,125	28.8	%
Rest of World		27,399		23,063		4,336	18.8	%
Total license revenues		77,100		61,639		15,461	25.1	%
Services
Americas		73,092		68,722		4,370	6.4	%
Rest of World		35,910		33,896		2,014	5.9	%
Total service revenues		109,002		102,618		6,384	6.2	%
Total revenues	$	186,102	$	164,257	$	21,845	13.3	%

25

License Revenues — The increase in license revenues was due primarily to increased sales of our Windows Management products particularly in the Americas and APAC sales regions of $7.1 million and $3.2 million, respectively. Our Windows products, led by migration, continued to perform well due to customers’ adoption of Exchange 2010 and Windows 2008 R2. Also, our Identity and Access Management products, the largest growth area in our Windows Management business, continued to expand and gain market share with the Quest One Identity Solution. Our 2010 license revenues were positively impacted by the weakening U.S. Dollar relative to certain non-U.S. Dollar currencies in 2010 partially offset by an appreciating U.S. Dollar relative to the Euro and British Pound. This resulted in slightly more U.S. Dollar equivalent revenues. Since certain of our international sales are denominated in non-U.S. Dollar currencies, the impact from foreign currency comprised approximately $1.5 million of the overall increase in license revenues.

Service Revenues — Service revenues are derived from post-contract technical support services (“maintenance”) and consulting and training services. The largest component of our services revenues is maintenance revenue. Maintenance revenues are generated from support and maintenance services relating to current year sales of new software products and from the renewal of existing maintenance agreements for software licenses sold in prior periods. The main driver of our growth in services revenues was maintenance renewals on our Windows Management products across all sales regions. Our maintenance revenues from Windows Management products in the Americas, EMEA and APAC sales regions increased by $2.6 million, $2.0 million and $1.4 million, respectively. Our professional services revenues contribution remained consistent with revenues from consulting and training services contributing 9.6% and 8.9% of total service revenues in the three months ended June 30, 2010 and 2009, respectively.

Maintenance revenues continue to contribute a larger percentage of our total revenues for two primary reasons: growth of our installed base of customers via new license sales and acquisitions and their related maintenance contracts. As our maintenance customer base grows, maintenance renewals have a larger influence on the maintenance revenue growth rate and the amount of new software license revenues has a diminishing effect. Therefore, the growth rate of total revenues does not necessarily correlate directly to the growth rate of new software license revenues in a given period. The primary determinant of changes in our maintenance revenue profile is the extent to which our customers renew their annual maintenance agreements, taking into account the number of products and licenses for which each customer renews, and the timing of the renewals by each such customer. If our maintenance renewals were to decline materially, our maintenance revenues, total revenues and cash flows would likely decline materially as well.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

	Three Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars			Percentage
Cost of Revenues:
Licenses	$	1,893	$	1,873	$	20		1.1	%
Services		15,636		14,499		1,137		7.8	%
Amortization of purchased technology		3,965		4,626		(661	)	(14.3	)%
Total cost of revenues	$	21,494	$	20,998	$	496		2.4	%

Cost of Licenses — Cost of licenses primarily consists of third-party software royalties, product packaging, delivery, and personnel costs. Cost of licenses as a percentage of license revenues was 2.5% and 3.0% for the three months ended June 30, 2010 and 2009, respectively. Cost of licenses was comparable to the same period in 2009.

Cost of Services — Cost of services primarily consists of personnel, outside consultants, facilities and systems costs used in providing maintenance, consulting and training services. Cost of services does not include development costs related to bug fixes and upgrades which are classified in research and development and which are not separately determinable. The impact from foreign currency comprised approximately 38.6% of the overall increase in cost of services. Cost of services as a percentage of service revenues was 14.3% and 14.1% in the three months ended June 30, 2010 and 2009, respectively.

Amortization of Purchased Technology — Amortization of purchased technology includes amortization of the fair value of purchased technology associated with acquisitions. The decrease is due to past acquisition-related purchased technology being fully amortized prior to April 1, 2010 coupled with fewer acquisitions completed during the past 18

26

months. We acquired Völcker in July 2010 and we expect the acquisition of Surgient to close during the third quarter of 2010 (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details). As a result of these acquisitions, we anticipate amortization of purchased technology to increase.

Operating Expenses

Year-over-year changes in the principal components of our operating expenses are as follows (in thousands, except for percentages):

	Three Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars			Percentage
Operating Expenses:
Sales and marketing	$	72,082	$	65,490	$	6,592		10.1	%
Research and development		36,543		35,510		1,033		2.9	%
General and administrative		19,836		17,678		2,158		12.2	%
Amortization of other purchased intangible assets		3,149		3,261		(112	)	(3.4	)%
Total operating expenses	$	131,610	$	121,939	$	9,671		7.9	%

Sales and Marketing — Sales and marketing expenses consist primarily of compensation and benefit costs for sales and marketing personnel, sales commissions, and costs of trade shows, travel and entertainment and various discretionary marketing programs. Sales and marketing expenses as a percentage of total revenues was 38.8%, which is comparable to 39.9% in the second quarter of 2009. The increase in sales and marketing expense during the three months ended June 30, 2010 over the comparable period in 2009 was due primarily to an increase of $3.9 million in personnel related costs, of which $3.5 million relates to higher commissions expense, and an increase of $1.2 million in travel related expenses. Our average full-time sales and marketing employee headcount for the second quarter of 2010 was 1,348 compared to 1,465 in the second quarter of 2009. The impact from foreign currency comprised approximately $1.2 million, or 18.7% of the overall increase in sales and marketing expenses.

Research and Development — Research and development expenses consist primarily of compensation and benefit costs for software developers who develop new products, fix bugs and design upgrades to existing products and at times provide engineering support for maintenance services, software product managers, quality assurance and technical documentation personnel, and payments made to outside software development consultants in connection with our ongoing efforts to enhance our core technologies and develop additional products. Research and development expenses as a percentage of total revenues was 19.6% and 21.6% for the three months ended June 30, 2010 and 2009, respectively. Research and development expenses increased mainly due to the impact of the decrease in value of the U.S. Dollar as a significant portion of our developers are located outside of the U.S. Foreign currency had a negative impact of $1.7 million on research and development expenses for the quarter ended June 30, 2010.

General and Administrative — General and administrative expenses consist primarily of compensation and benefit costs for our executive, finance, legal, human resources, administrative and information services personnel, and professional fees for audit, tax and legal services. General and administrative expenses as a percentage of total revenues was 10.7%, which is comparable to 10.8% in the second quarter of 2009. The increase in general and administrative expense during the three months ended June 30, 2010 over the comparable period in 2009 was due primarily to an increase of $2.0 million in personnel related costs, of which $1.1 million relates to higher stock-based compensation as a result of restricted stock and stock option awards issued in the second half of 2009. The impact from foreign currency comprised approximately 14.1% of the overall increase in general and administrative expenses.

Amortization of Other Purchased Intangible Assets — Amortization of other purchased intangible assets includes the amortization of customer lists, trademarks and trade names, non-compete agreements and maintenance contracts associated with acquisitions. The decrease is due to past acquisition-related other purchased intangible assets being fully amortized prior to April 1, 2010 coupled with fewer acquisitions completed during the past 18 months. We acquired Völcker in July 2010 and we expect the acquisition of Surgient to close during the third quarter of 2010 (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details). As a result of these acquisitions we anticipate amortization of other purchased intangible assets to increase.

27

Other (Expense) Income, Net

Other (expense) income, net consists of the following (in thousands):

	Three Months Ended June 30						Increase (Decrease)
	2010			2009			Dollars			Percentage
Interest income	$	532		$	487		$	45		9.2	%
Interest expense		(1,108	)		(495	)		(613	)	123.8	%
Foreign currency (losses) gains, net		(4,671	)		5,396			(10,067	)	(186.6	)%
Forward foreign currency contracts gains (losses), net		1,411			(799	)		2,210		(276.6	)%
Unrealized gains (losses) on ARS		2,456			(605	)		3,061		(506.0	)%
Unrealized (losses) gains on Put Options		(2,458	)		733			(3,191	)	(435.3	)%
Other (expense) income, net		(5	)		63			(68	)	(107.9	)%
Total other (expense) income, net	$	(3,843	)	$	4,780		$	(8,623	)	(180.4	)%

Other (expense) income, net includes gains and losses from foreign exchange fluctuations, interest expense on our borrowings and gains or losses on other financial assets as well as a variety of other non-operating expenses. Our foreign currency gains or losses are predominantly attributable to translation gains or losses relative to the U.S. Dollar on the re-measurement of net monetary assets, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. The largest impact to other (expense) income, net this quarter was attributed to a foreign currency loss of $4.7 million compared to a gain of $5.4 million in the comparable period of 2009. This was partially offset by a forward foreign currency gain of $1.4 million compared to a loss of $0.8 million in the second quarter of 2009. Our forward foreign currency contracts gains (losses), net relate to the changes in fair value of our forward foreign currency contracts not designated as hedging instruments. Unrealized gains (losses) on our auction rate securities increased by $3.1 million offset by a corresponding decrease in unrealized (losses) gains on our Put Options of $3.2 million (see Note 4 – Cash and Cash Equivalents and Investments of our Notes to Condensed Consolidated Financial Statements for additional information regarding our auction rate securities and Put Options). Interest expense was $1.1 million and $0.5 million in the three months ended June 30, 2010 and 2009, respectively. The increase in interest expense is due to debt agreements entered during the second half of 2009. See Note 5 – Loans Payable of our Notes to Condensed Consolidated Financial Statements for additional information regarding our debt agreements.

Income Tax Provision

During the three months ended June 30, 2010, the provision for income taxes increased to $11.8 million from $5.6 million in the comparable period in 2009. The effective income tax rate for the three months ended June 30, 2010 was approximately 40.3% compared to 21.6% in the comparable period of 2009. The increase is primarily a result of the mix of pre-tax income between high and low tax jurisdictions, and other discrete items impacting the quarter ended June 30, 2010. Discrete items included an increase to income tax provision relating to the write-off of deferred tax assets associated with cancelled, forfeited and expired stock options recorded during the three months ended June 30, 2010, and adjustments related to our adoption of FASB’s new accounting guidance on business combinations and enactment of California legislation during the period.

28

Comparison of Six Months Ended June 30, 2010 and 2009

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

	Six Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars		Percentage
Revenues:
Licenses
Americas	$	88,296	$	77,012	$	11,284	14.7	%
Rest of World		53,785		46,997		6,788	14.4	%
Total license revenues		142,081		124,009		18,072	14.6	%
Services
Americas		143,684		141,327		2,357	1.7	%
Rest of World		71,508		64,518		6,990	10.8	%
Total service revenues		215,192		205,845		9,347	4.5	%
Total revenues	$	357,273	$	329,854	$	27,419	8.3	%

License Revenues — The increase in license revenues was due primarily to increased sales of our Windows Management products across all sales regions. Our license revenues from Windows Management products in the Americas, EMEA and APAC sales regions increased by $6.0 million, $4.7 million and $3.6 million, respectively. In addition, increased sales in our Database Management products, particularly in our Americas sales region of $5.6 million contributed to the growth in our license revenues. Our 2010 license revenues were positively impacted by the weakening U.S. Dollar relative to certain non-U.S. Dollar currencies in 2010, partially offset by an appreciating U.S. Dollar relative to the Euro and British Pound. This resulted in more U.S. Dollar equivalent revenues for several currencies. Since certain of our international sales are denominated in non-U.S. Dollar currencies, the impact from foreign currency comprised approximately $4.3 million, or 23.7%, of the overall increase in license revenues.

Service Revenues — The main driver of our growth in services revenues was maintenance renewals on our Windows Management products across all sales regions. Our maintenance revenues from Windows Management products in the Americas, EMEA and APAC sales regions increased by $4.9 million, $3.8 million and $2.2 million, respectively. Revenue from consulting and training services as a percentage of total service revenues was approximately 9.7% and 8.6% of total service revenues in the six months ended June 30, 2010 and 2009, respectively.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

	Six Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars			Percentage
Cost of Revenues:
Licenses	$	3,714	$	3,542	$	172		4.9	%
Services		30,360		28,260		2,100		7.4	%
Amortization of purchased technology		8,458		9,941		(1,483	)	(14.9	)%
Total cost of revenues	$	42,532	$	41,743	$	789		1.9	%

Cost of Licenses — Cost of licenses as a percentage of license revenues was 2.6% and 2.9% for the six months ended June 30, 2010 and 2009, respectively. Cost of licenses was comparable to the same period in 2009.

29

Cost of Services — Cost of services as a percentage of service revenues was 14.1% and 13.7% in the six months ended June 30, 2010 and 2009, respectively. The impact from foreign currency comprised approximately 51.2% of the overall increase in cost of services.

Amortization of Purchased Technology — The decrease is due to past acquisition-related purchased technology being fully amortized prior to January 1, 2010 coupled with fewer acquisitions completed during the past 18 months. We acquired Völcker in July 2010 and we expect the acquisition of Surgient to close during the third quarter of 2010 (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details), as a result of these acquisitions we anticipate amortization of purchased technology to increase.

Operating Expenses

Year-over-year changes in the principal components of our operating expenses are as follows (in thousands, except for percentages):

	Six Months Ended June 30				Increase (Decrease)
	2010		2009		Dollars			Percentage
Operating Expenses:
Sales and marketing	$	140,422	$	132,028	$	8,394		6.4	%
Research and development		72,016		73,206		(1,190	)	(1.6	)%
General and administrative		39,173		36,200		2,973		8.2	%
Amortization of other purchased intangible assets		6,325		6,667		(342	)	(5.1	)%
Total operating expenses	$	257,936	$	248,101	$	9,835		4.0	%

Sales and Marketing — Sales and marketing expenses as a percentage of total revenues for the six months ended June 30, 2010 was 39.3%, which is comparable to 40.0% in the first half of 2009. The increase in sales and marketing expense during the six months ended June 30, 2010 over the comparable period in 2009 was due primarily to an increase in personnel related costs of $5.3 million, $4.5 million of which relates to commissions expense. Our average full time sales and marketing employee headcount for the six months ended June 30, 2010 decreased by 101. Also, travel-related expenses increased by $1.5 million compared to the same period in 2009. The impact from foreign currency comprised approximately 48.2%, or $4.0 million of the overall increase in sales and marketing expenses.

Research and Development — Research and development expenses as a percentage of total revenues was 20.1% and 22.2% for the six months ended June 30, 2010 and 2009, respectively. The decrease in research and development expense during the six months ended June 30, 2010 as compared to the same period in 2009 was due primarily to a $1.5 million decrease in general expenses (mainly consulting and other professional fees). Personnel related costs were comparable in the same period last year. Our average full-time employee headcount was 1,116 compared to 1,226 in the first half of 2009. Foreign currency had a negative impact of $3.2 million on research and development expenses for the six months ended June 30, 2010.

General and Administrative — General and administrative expenses as a percentage of total revenues remained flat at 11.0% for the six months ended June 30, 2010 compared to the same period in 2009. The increase in general and administrative expense during the six months ended June 30, 2010 over the comparable period in 2009 was due primarily to an increase of $3.2 million in personnel related costs, of which $1.7 million relates to higher stock-based compensation as a result of restricted stock and stock option awards issued in the second half of 2009. The impact from foreign currency comprised approximately 26.3% of the overall increase in general and administrative expenses.

Amortization of Other Purchased Intangible Assets — The decrease is due to past acquisition-related other purchased intangible assets being fully amortized prior to January 1, 2010 coupled with fewer acquisitions completed during the past 18 months. We acquired Völcker in July 2010 and we expect the acquisition of Surgient to close during the third quarter of 2010 (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details). As a result of these acquisitions we anticipate amortization of other purchased intangible assets to increase.

30

Other (Expense) Income, Net

Other (expense) income, net consists of the following (in thousands):

	Six Months Ended June 30						Increase (Decrease)
	2010			2009			Dollars			Percentage
Interest income	$	844		$	1,194		$	(350	)	(29.3	)%
Interest expense		(2,238	)		(725	)		(1,513	)	208.7	%
Foreign currency gains (losses), net		(8,853	)		986			(9,839	)	(997.9	)%
Forward foreign currency contracts gains (losses), net		2,506			(1,408	)		3,914		(278.0	)%
Unrealized gains on ARS		2,970			5,778			(2,808	)	(48.6	)%
Unrealized losses on Put Options		(2,978	)		(5,376	)		2,398		(44.6	)%
Other income, net		300			185			115		62.2	%
Total other (expense) income, net	$	(7,449	)	$	634		$	(8,083	)	(1,274.9	)%

The largest impact to other (expense) income, net this period was attributed to a foreign currency loss of $8.9 million compared to a gain of $1.0 million in the comparable period of 2009 due to the relative strength in the U.S. Dollar that negatively impacted our net monetary asset positions. This was partially offset by an increase in forward foreign currency contract gains (losses) of $3.9 million. Unrealized gains on our auction rate securities decreased by $2.8 million offset by a corresponding decrease in unrealized losses on our Put Options of $2.4 million (see Note 4 – Cash and Cash Equivalents and Investments of our Notes to Condensed Consolidated Financial Statements for additional information regarding our auction rate securities and Put Options). Interest expense was $2.2 million and $0.7 million in the six months ended June 30, 2010 and 2009, respectively. The increase in interest expense is due to debt agreements entered during the second half of 2009. See Note 8 – Loans Payable of our Notes to Condensed Consolidated Financial Statements for additional information regarding our debt agreements.

Income Tax Provision

During the six months ended June 30, 2010, the provision for income taxes decreased to $16.4 million from $10.3 million in the comparable period in 2009. The effective income tax rate for the six months ended June 30, 2010 was approximately 33.1% compared to 25.2% in the comparable period of 2009. The increase is primarily a result of the mix of pre-tax income between high and low tax jurisdictions, and other discrete items impacting the quarter ended June 30, 2010. Discrete items included an increase to income tax provision relating to the write-off of deferred tax assets associated with cancelled, forfeited and expired stock options recorded during the three months ended June 30, 2010, and adjustments related to our adoption of FASB’s new accounting guidance on business combinations and enactment of California legislation during the period.

Liquidity and Capital Resources

Cash and cash equivalents and short-term and long-term investments were approximately $439.2 million and $385.5 million as of June 30, 2010 and December 31, 2009, respectively.

At June 30, 2010, we held within short-term investments $4.5 million (with a fair value of $4.2 million) of investment grade municipal notes with an auction reset feature (“auction rate securities” or “ARS”). These securities are collateralized by higher education funded student loans which are supported by the federal government as part of the Federal Family Education Loan Program (“FFELP”). We exercised our Put Options on July 1, 2010 under our Rights Agreements and we redeemed our remaining ARS of $4.5 million (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Balance Sheet for further details).

31

Summarized annual cash flow information is as follows (in thousands):

	Six Months Ended June 30
	2010			2009
Cash provided by operating activities	$	100,580		$	72,564
Cash used in investing activities		(33,975	)		(4,736	)
Cash used in financing activities		(45,230	)		(1,066	)
Effect of exchange rate changes		1,833			383
Net increase in cash and cash equivalents	$	23,208		$	67,145

Operating Activities

Cash provided by operating activities is primarily comprised of net income, adjusted for non-cash activities such as depreciation and amortization and compensation expense associated with share-based payments. These non-cash adjustments represent charges reflected in net income and, therefore, to the extent that non-cash items increase or decrease our future operating results, there will be no corresponding impact on our cash flows. After excluding the effects of these non-cash charges, the primary changes in cash flows relating to operating activities resulted from changes in operating assets and liabilities. The analyses of the changes in our operating assets and liabilities are as follows:

• Accounts receivable, net decreased by $37.4 million to $120.2 million at June 30, 2010 compared to December 31, 2009 resulting in a decrease in operating assets and reflecting a cash inflow of $33.3 million for the six months ended June 30, 2010. Days sales outstanding (“DSO”), improved to 59 days at June 30, 2010 compared to 75 days at December 31, 2009. Our daily sales decreased to $2.0 million for the quarter ended June 30, 2010 compared to $2.1 million for the quarter ended December 31, 2009. Collection of accounts receivable and related DSO could fluctuate in future periods due to the timing and amount of our revenues and their linearity and the effectiveness of our collection efforts.

• Deferred revenue decreased by $3.1 million at June 30, 2010 from $372.1 million at December 31, 2009, resulting in a decrease in operating liabilities and reflecting a cash outflow of $3.1 million for the six months ended June 30, 2010. The decrease in deferred revenue was due primarily to the decrease in sales of our time-based software licenses and to the slower growth of our software post-contract technical support services customer base.

• Accrued compensation decreased by $6.1 million to $39.7 million at June 30, 2010 compared to December 31, 2009 resulting in a decrease in operating liabilities and reflecting a cash outflow of $7.1 million for the six months ended June 30, 2010. The decrease in accrued compensation was primarily due to the decreases in accrued commissions and accrued bonuses by $5.4 million and $2.0 million, respectively. Our full-time employee headcount decreased to 3,279 at June 30, 2010 compared to 3,365 at December 31, 2009.

• Income taxes payable increased by $12.3 million to $4.2 million at June 30, 2010 compared to December 31, 2009 resulting in an increase in operating liabilities and reflecting a cash inflow of $8.7 million for the six months ended June 30, 2010. Net cash paid for income taxes for the six months ended June 30, 2010 was $2.3 million.

Investing Activities

Cash flows from investing activities in the six months ended June 30, 2010 included $6.8 million in capital expenditures, $132.3 million from purchases of investment securities, and $2.0 million funded to one of our cost method investees. We received $107.2 million in proceeds from sale and maturities of our investment securities. Included in the proceeds from sale and maturities of our investment securities were redemptions of approximately $43.0 million par value of our ARS during the six months ended June 30, 2010, respectively. We exercised our Put Options on July 1, 2010 under the Agreements, and redeemed our remaining ARS of $4.5 million par value (refer to Note 16 – Subsequent Events of our Notes to Condensed Consolidated Financial Statements for further details).

We expect that we will continue to purchase property and equipment needed in the normal course of our business. We plan to use excess cash generated from operations to invest in short and long-term investments consistent with past investment practices. Also, we plan to use cash generated from operations and/or proceeds from our investment securities to fund other strategic investment and acquisition opportunities that we continue to evaluate. In July 2010, we acquired Völcker, a German company with a product called ActiveEntry in the Identity Access Management market (refer to Note 16

32

– Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details). This acquisition further enables us to expand our identity management capabilities beyond the Microsoft infrastructure. In addition, we signed a definitive agreement to acquire Surgient, an Austin, Texas-based cloud management company, and this acquisition is expected to close during the third quarter of 2010 (refer to Note 16- Subsequent Events of our Notes to Condensed Consolidated Financial Statements for additional details).

Financing Activities

Cash used in financing activities in the six months ended June 30, 2010 included $37.4 million paid for repurchases of our common stock and $32.3 million for repayment of loans outstanding. We received net proceeds of $23.3 million from the issuance of our common stock due to exercises of stock options.

In August 2009, our Board of Directors authorized a stock repurchase of up to $100 million of our common stock. Refer to Note 8 – Stockholders’ Equity for further information on our stock repurchases. During the three months ended June 30, 2010, we repurchased 0.3 million shares under this stock repurchase authorization at a weighted-average price per share of $16.67, for a total cost of $5.3 million. A total of $51.5 million remains available pursuant to this stock repurchase authorization.

We have fully paid the $32.1 million balance outstanding on our UBS Financial Services line of credit from the proceeds on redemptions of our auction rate securities of approximately $43.0 million for the six months ended June 30, 2010. We were in compliance with all debt-related covenants at June 30, 2010. For additional information on our loans payable, please refer to Note 5 – Loans Payable of our Notes to Condensed Consolidated Financial Statements.

As we continue to evaluate potential acquisitions, potential future stock repurchases or other general corporate expenditures which may be in excess of current cash available within certain operating entities, sourcing cash to fund these activities requires financial flexibility afforded by financing instruments. As such, we plan to continue to evaluate potential debt financings when and if reasonable financing terms become available to us.

Based on our current operating plan, we believe that our existing cash, cash equivalents, investment balances, cash flows from operations and available debt financing will be sufficient to finance our operational cash needs through at least the next 12 to 24 months. Our ability to generate cash from operations is subject to substantial risks described under Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009. One of these risks is that our future business does not stay at a level that is similar to, or better than, our recent past. In that event, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash, cash equivalents, investment balances and debt financing to support our working capital and other cash requirements. Also, acquisitions are an important part of our business model. As such, significant amounts of cash could and will likely be used in the future for additional acquisitions or strategic investments. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through public or private equity or, as discussed above, debt financing or from other sources. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us.

Recently Adopted Accounting Pronouncements

See Note 2 – Recent Accounting Pronouncements of our Notes to Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, asset valuations (including accounts receivable, goodwill and intangible assets), share-based compensation, income taxes and functional currencies for purpose of consolidation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Our estimates form the basis for making judgments about amounts and timing of revenue and expenses, the carrying values of assets, and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with

33

the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K for the year ended December 31, 2009 under Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no material changes to our critical accounting policies or estimates during the six months ended June 30, 2010.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Exchange Risk

We are a U.S. Dollar functional company and transact business in a number of different foreign countries around the world. In most instances, revenues are collected and operating expenses are paid in the local currency of the country in which we are transacting. Accordingly, we are exposed to both transaction and translation risk relating to changes in foreign exchange rates.

Our exposure to foreign exchange risk originates both from our foreign operations net profits and losses denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities in our foreign subsidiaries. These exposures have the potential to produce either gains or losses depending on the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Our cumulative currency gains or losses in any given period may be lessened by the economic benefits of diversification and the correlative relationships of different currencies, but there can be no assurance that this pattern will continue to be true in future periods. During the three and six months ended June 30, 2010, we had a positive effect of $1.6 million and $4.8 million, respectively, on total revenues and a negative effect of $3.6 million and $9.1 million, respectively, on total expenses related to foreign currency fluctuation when comparing 2010 rates to 2009. In addition, during the three months and six months ended June 30, 2010, we had a $4.7 million and $8.9 million, respectively, in foreign currency loss within other (expense) income, net compared to a $5.4 million and $1.0 million foreign currency gain in the comparable periods in 2009.

The foreign currencies to which we currently have the most significant exposure are the Euro, the Canadian Dollar, the British Pound, the Australian Dollar and the Russian Ruble. During 2009, we implemented a limited foreign exchange hedging program. We enter into hedges in the form of forward foreign currency contracts to reduce the range of outcomes foreign currency rate changes can have on non-functional currency denominated forecasted transactions and balance sheet positions, which include certain monetary assets and liabilities denominated in foreign currencies. The forward foreign currency contracts are carried at fair value and denominated in various currencies as listed in the tables below. The duration of forward contracts ranges from less than one month to nine months. A description of our accounting for forward foreign currency contracts is included in Note 12 – Derivative Instruments of our Notes to Condensed Consolidated Financial Statements.

The magnitude of success of our hedging activities depends upon the accuracy of our estimates of various balances and transactions denominated in non-functional currencies. To the extent our estimates are correct, gains and losses on our forward foreign currency contracts will be offset by corresponding losses and gains on the underlying transactions. In order to monitor the financial impact of our foreign currency hedges, we subject our hedges to a stress test. This test is intended to quantify the impact to our financial statements of an abnormal change in the foreign currency rates in which we do business. When subjected to a 10% adverse change, we estimated that the fair value of our contracts would decline by $9.8 million. When subjected to a 20% adverse change, we estimated that the fair value of our contracts would decline by $19.6 million.

We do not use forward foreign currency contracts for speculative or trading purposes. We enter into forward foreign currency contracts with reputable financial institutional counterparties whose financial health we monitor. To date, we have not experienced nonperformance by any of these counterparties and anticipate performance by all counterparties.

The following table summarizes the notional amounts of our outstanding forward foreign currency contracts at June 30, 2010 and December 31, 2009. All contracts have maturities of nine months or less. ( in U.S. Dollars in thousands):

Currency	June 30 2010		December  31 2009
Australian Dollar	$	3,918	$	2,545
Canadian Dollar		8,482		11,554
Danish Krone		986		1,214
Euro		53,240		21,991

34

Currency	June 30 2010		December  31 2009
British Pound		19,148		9,965
Israeli Shekel		2,055		1,947
Brazil Real		3,294		—
Swedish Krona		257		—
Norwegian Krone		614		—
Russian Ruble		5,828		5,586
Total	$	97,822	$	54,802

Interest Rate Risk

Our exposure to market interest-rate risk relates primarily to our investment portfolio. We traditionally do not use derivative financial instruments to hedge the market risks of our investments. We place our investments with high-quality issuers and money market funds and articulate allocation limits in our investment policy to any one issuer other than the United States government. Our investment portfolio as of June 30, 2010 consisted of money market funds, U.S. Treasuries, US agency securities, commercial paper, certificates of deposit, corporate bonds and ARS. Investments purchased with an original maturity of three months or less are considered to be cash equivalents. We classify our ARS as trading securities and all other investments as available-for-sale securities. Trading securities are carried at fair value, with changes in fair value reported in earnings. 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 June 30, 2010, we held within short-term investments $4.5 million (with a fair value of $4.2 million) of ARS. The Dutch auction process that resets the applicable interest rate at predetermined calendar intervals is intended to provide liquidity to the holder of the ARS by matching buyers and sellers within a market context enabling the holder to gain immediate liquidity by selling such interests at par or rolling over their investment. The auctions for these securities began failing in 2008. When auctions fail, our securities earn interest based on formulaic multiples of municipal bond indices such as the JJ Kenny Index or the S&P High Grade Index. The resulting interest rate has been highly sensitive to changes in the short term structure of interest rates and asset backed securities. We exercised our Put Options on July 1, 2010 under our Rights Agreement and our remaining ARS of $4.5 million were redeemed (refer to Note 16 – Subsequent Events of our Condensed Consolidated Financial Statements for further details).

Information about our investment portfolio is presented in the table below, which states the amortized book value and related weighted-average interest rates by year of maturity (in thousands):

	Amortized Book Value		Weighted Average Rate
Investments maturing by June 30
2011(1)	$	301,200	0.28	%
2012		50,300	1.12	%
2013		23,485	1.63	%
2014		—	—
2015		—	—
Thereafter		—	—
Total portfolio	$	374,985	0.47	%

(1) Includes $251.6 million in cash equivalents.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

35

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2010 as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Exchange Act. Based on that evaluation, our chief executive officer and chief financial officer have concluded that, as of that date, our disclosure controls and procedures as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act were effective, at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

36

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

The information set forth under Note 15 – Commitments and Contingencies of our Notes to Condensed Consolidated Financial Statements, included in Part I, Item 1, Financial Statements, of this Report, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see the section entitled Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 1A. Risk Factors

You should carefully consider the risks described in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009, as our business, financial condition and results of operations could be adversely affected by any of the risks and uncertainties described therein. There have been no material changes in our risk factors from those disclosed in our 2009 Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The table below summarizes information about our purchases of equity securities registered pursuant to Section 12 of the Exchange Act during the quarterly period ended June 30, 2010.

Period	Total  Number of Shares of Common Stock Purchased (1)	Price Paid per Share  of Common Stock (2)		Total Number of Shares of Common Stock Purchased  as Part of Publicly Announced Plans or Programs (1)	Maximum Approximate  Dollar Value of Shares of Common Stock that May Yet Be Purchased Under the Plans or Programs (in millions)
April 1, 2010 through April 30, 2010	—	$	—	—	$	56.8
May 1, 2010 through May 31, 2010	316,937	$	16.67	316,937	$	51.5
June 1, 2010 through June 30, 2010	—	$	—	—	$	51.5
Total	316,937	$	16.67	316,937	$	51.5

(1) In August 2009, the Board of Directors authorized a plan to repurchase up to $100 million of our common stock. Any stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

(2) The price paid per share of common stock does not include the related transaction costs.

37

Item 6. Exhibits

Exhibit Number	Exhibit Title
3.1*	Certificate of Incorporation of Quest Software, Inc. (incorporated by reference to our Current Report on Form 8-K filed on April 30, 2009)
3.2*	Bylaws of Quest Software, Inc. (incorporated by reference to our Current Report on Form 8-K filed on April 30, 2009)
4.1*	Form of Registrant’s Specimen Common Stock Certificate (incorporated by reference to our Registration Statement on Form S-1 and all amendments thereto filed on June 11, 1999 (File No. 333-80543))
31.1	Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2	Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

* Incorporated by reference

38

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	QUEST SOFTWARE, INC.
Date: August 5, 2010	/S/    SCOTT J. DAVIDSON
	Scott J. Davidson
	Senior Vice President, Chief Financial Officer
	/S/    SCOTT H. REASONER
	Scott H. Reasoner
	Vice President, Corporate Controller

39

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Douglas F. Garn, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Quest Software, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 5, 2010

/S/    DOUGLAS F. GARN        

Douglas F. Garn

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Scott J. Davidson, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Quest Software, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 5, 2010

/S/    SCOTT J. DAVIDSON        

Scott J. Davidson

Senior Vice President, Chief Financial Officer

EX-32.1

Exhibit 32.1

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to

18 U.S.C. Section 1350, as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350), Douglas F. Garn, Chief Executive Officer of Quest Software, Inc. (the “Company”), and Scott J. Davidson, Chief Financial Officer of the Company, each hereby certifies that, to the best of his or her knowledge:

1. The Company’s Quarterly Report on Form 10-Q for the three months ended June 30, 2010, to which this Certification is attached as Exhibit 32.1 (the “Quarterly Report”) fully complies with the requirements of Section 13(a) or Section 15(d) of the Exchange Act, and

2. The information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

In Witness Whereof, the undersigned have set their hands hereto as of the 5^th day of August, 2010.

/S/    DOUGLAS F. GARN	/S/    SCOTT J. DAVIDSON
Douglas F. Garn	Scott J. Davidson
Chief Executive Officer	Chief Financial Officer

This certification accompanies the Form 10-Q to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Quest Software, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such filing.