NOTE 14 — 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 20.5 million as of June 30, 2012. 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, 2012, there were 4.9 million shares available for grant under the 2008 Plan.

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, 2012 and 2011:


	Three Months Ended June 30					Six Months Ended June 30
	2012 (a)		2011			2012			2011
Expected volatility		n/a		34	%		36	%		34	%
Expected term (in years)		n/a		5.3			5.7			5.7
Risk-free interest rate		n/a		1.9	%		1.0	%		2.1	%
Expected dividend yield		None		None			None			None

(a)	No options were granted during the three months ended June 30, 2012.

A summary of the activity of employee stock options during the six months ended June 30, 2012, and details regarding the options outstanding and exercisable at June 30, 2012, 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, 2011		15,779		$	17.26
Granted		133		$	19.36
Exercised		(1,418	)	$	16.79
Canceled/forfeited/expired		(578	)	$	18.39

Outstanding at June 30, 2012		13,916		$	17.27		7.04	$	146,675

Vested or expected to vest at June 30, 2012 ⁽²⁾		12,939		$	17.23		6.91	$	136,847

Exercisable at June 30, 2012		5,680		$	15.41		4.89	$	70,426

(1)	These amounts represent the difference between the exercise price and $27.81, the closing price of Quest Software, Inc. stock on June 30, 2012 as reported on the NASDAQ National Market, for all options outstanding that have an exercise price currently below the closing price.

(2)	Contractual vesting may be altered by the ultimate terms and conditions associated with the completion of the pending merger transaction with Dell. (See Note 1).

The weighted-average fair value of options granted during the six months ended June 30, 2012 and 2011 was $6.75 and $8.99, respectively. The total intrinsic value of options exercised was $10.0 million and $9.0 million for the six months ended June 30, 2012 and 2011, respectively. The total fair value of options vested during the six months ended June 30, 2012 and 2011 was $14.5 million and $12.6 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 a Profit Sharing Plan. 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. Additionally, a portion of each RSU award is settled in cash, only to the extent necessary to pay the minimum tax withholding or any government levies on the restricted stock unit.

A summary of our RSU awards activity during the six months ended June 30, 2012 is provided below:


	Number of Shares			Weighted-Average Grant Date Fair Value (per share)
Nonvested at January 1, 2012		236,331		$	15.88
Granted		—		$	—
Vested		(128,948	)	$	15.36
Forfeited		(16,268	)	$	15.76

Nonvested at June 30, 2012⁽¹⁾⁽²⁾		91,115		$	16.64

(1)	81,224 of these shares are expected to vest.

(2)	Contractual vesting may be altered by the ultimate terms and conditions associated with the completion of the pending merger transaction with Dell (See Note 1).

The total fair value of RSU awards vested during the six months ended June 30, 2012 and 2011 was $2.0 million and $4.2 million, respectively.

Stock-Based Compensation Expense

The following table presents the statement of operations classification of all stock-based compensation expense for the three months and six months ended June 30, 2012 and 2011 (in thousands):


	Three Months Ended June 30				Six Months Ended June 30
	2012		2011		2012		2011
Cost of services	$	217	$	238	$	450	$	554
Sales and marketing		1,736		1,682		3,464		3,791
Research and development		1,387		1,614		2,884		3,767
General and administrative		1,851		1,958		4,476		4,794

Total stock-based compensation		5,191		5,492		11,274		12,906
Tax benefit associated with stock-based compensation expense ⁽¹⁾		2,035		2,125		4,419		4,995

Reduction of net income	$	3,156	$	3,367	$	6,855	$	7,911

(1)

The recognized tax benefit related to stock-based compensation expense was estimated to be 39.2% for the three months and six months ended June 30, 2012, and 38.7% for the three months and six months ended June 30, 2011. This approximates the blended Federal and State statutory tax rate after the benefit for state taxes.

As of June 30, 2012, total unrecognized stock-based compensation cost related to unvested stock option awards was $42.8 million, which is expected to be recognized over a weighted-average period of 3.8 years and total unrecognized stock-based compensation cost related to unvested RSU awards was $1.3 million, which is expected to be recognized over a weighted-average period of 6 months. The ultimate recognition of this stock-based compensation expense may be impacted by the final terms and conditions associated with the pending merger transaction with Dell (See Note 1).