1
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, 2001
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)
CALIFORNIA 33-0231678
- ----------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8001 IRVINE CENTER DRIVE
IRVINE, CALIFORNIA 92618
- ------------------------------------------------ ---------------
(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 [ ]
The number of shares outstanding of the Registrant's Common Stock, no
par value, as of August 01, 2001 was 87,827,932.
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QUEST SOFTWARE, INC.
FORM 10-Q
INDEX
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2000
and June 30, 2001 (unaudited)..................................................3
Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2000 and 2001 (unaudited)................................4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2000 and 2001 (unaudited).......................................5
Consolidated Statements of Comprehensive Operations for the Three
and Six Months Ended June 30, 2000 and 2001 (unaudited)........................6
Notes to Consolidated Financial Statements (unaudited)...............................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..........................................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk..........................25
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.................................26
Item 6. Exhibits and Reports on Form 8-K....................................................26
Signatures...................................................................................27
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PART I
FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
QUEST SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
JUNE 30,
DECEMBER 31, 2001
2000 (UNAUDITED)
------------ -----------
Current assets:
Cash and cash equivalents $ 25,155 $ 68,526
Short-term marketable securities available for sale 8,587 37,106
Accounts receivable, net 38,443 39,347
Prepaid expenses and other current assets 11,390 13,695
Income taxes receivable 1,558 1,734
Deferred income taxes 14,833 14,801
--------- ---------
Total current assets 99,966 175,209
Property and equipment, net 46,840 56,603
Long-term marketable securities available for sale 118,084 71,608
Goodwill and purchased intangible assets, net 255,858 222,967
Deferred income taxes 3,001 3,001
Other assets 10,423 9,799
--------- ---------
Total assets $ 534,172 $ 539,187
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,503 $ 4,741
Accrued compensation 9,350 14,777
Other accrued expenses 22,491 18,424
Deferred revenue 32,052 46,612
--------- ---------
Total current liabilities 69,396 84,554
Long-term liabilities and other 6,422 6,337
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized; no shares issued or outstanding -- --
Common stock, no par value, 150,000 shares authorized; 86,710 and 87,840 issued and
outstanding at December 31, 2000 and June 30, 2001, respectively 500,324 518,641
Accumulated deficit (23,214) (50,946)
Accumulated other comprehensive income 132 91
Notes receivable from sale of common stock (18,888) (19,490)
--------- ---------
Total shareholders' equity 458,354 448,296
--------- ---------
Total liabilities and shareholders' equity $ 534,172 $ 539,187
========= =========
See accompanying notes to the consolidated financial statements.
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QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ------------------------
2000 2001 2000 2001
-------- -------- -------- ---------
Revenues:
Licenses $ 28,528 $ 49,158 $ 50,423 $ 97,587
Services 8,126 17,704 14,956 32,386
-------- -------- -------- ---------
Total revenues 36,654 66,862 65,379 129,973
Cost of revenues:
Licenses 870 1,124 1,505 2,013
Services 2,252 4,411 4,122 8,489
Amortization of purchased intangible assets 1,101 1,905 1,758 3,940
-------- -------- -------- ---------
Total cost of revenues 4,223 7,440 7,385 14,442
-------- -------- -------- ---------
Gross profit 32,431 59,422 57,994 115,531
Operating expenses:
Sales and marketing 16,962 31,221 30,876 62,081
Research and development 9,336 15,457 16,702 29,387
General and administrative 3,635 6,086 6,732 12,439
Other compensation costs and intangible amortization 8,031 15,469 15,409 31,451
-------- -------- -------- ---------
Total operating expenses 37,964 68,233 69,719 135,358
-------- -------- -------- ---------
Loss from operations (5,533) (8,811) (11,725) (19,827)
Other income, net 3,665 1,727 4,644 3,504
Losses on equity investments - (1,480) - (1,480)
-------- -------- -------- ---------
Loss before income tax provision (1,868) (8,564) (7,081) (17,803)
Income tax provision 2,541 4,384 3,013 9,927
-------- -------- -------- ---------
Net loss $ (4,409) $(12,948) $(10,094) $ (27,730)
======== ======== ======== =========
Net loss per share:
Basic and Diluted $ (0.05) $ (0.15) $ (0.12) $ (0.32)
======== ======== ======== =========
Weighted average shares:
Basic and Diluted 85,526 87,520 83,351 87,267
See accompanying notes to the consolidated financial statements.
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QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
---------------------------
2000 2001
--------- ---------
Cash flows from operating activities:
Net loss $ (10,094) $ (27,730)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 16,783 36,793
Compensation expense associated with stock option grants 1,579 3,053
Accrued interest receivable from shareholders (98) (602)
Provision for bad debts 150 367
Loss on equity investments -- (1,480)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable (354) (2,150)
Prepaid expenses and other current assets (4,355) (1,559)
Deferred taxes 27 70
Other assets (2,657) 860
Accounts payable 218 (700)
Accrued compensation 1,186 5,636
Income taxes payable 2,736 9,528
Other accrued expenses (2,520) (3,912)
Other liabilities -- (60)
Deferred revenue 6,009 14,984
--------- ---------
Net cash provided by operating activities 8,610 33,098
Cash flows from investing activities:
Purchases of property and equipment (25,471) (14,540)
Cash paid for acquisitions, net of cash acquired (30,824) --
Purchases of marketable securities (258,233) (86,575)
Sales and maturities of marketable securities 95,580 104,491
--------- ---------
Net cash (used)/provided by investing activities (218,948) 3,376
Cash flows from financing activities:
Repayment of notes payable (1,410) --
Repayment of capital lease obligations (332) (290)
Proceeds from exercise of stock options 803 3,965
Proceeds from employee stock purchase plan 1,417 2,992
Proceeds from issuance of common stock, net 253,469 --
--------- ---------
Net cash provided by financing activities 253,947 6,667
Effect of exchange rate changes on cash and cash equivalents 38 230
--------- ---------
Net increase in cash and cash equivalents 43,647 43,371
Cash and cash equivalents, beginning of period 39,643 25,155
--------- ---------
Cash and cash equivalents, end of period $ 83,290 $ 68,526
========= =========
Supplemental disclosures of consolidated cash flow information:
Cash paid for:
Interest $ 120 $ 68
========= =========
Income taxes $ 270 $ 137
========= =========
Supplemental schedule of noncash investing and financing activities:
Unrealized loss from available-for-sale securities $ 515 $ 41
========= =========
Tax benefit related to stock option exercises $ 2,843 $ 9,724
========= =========
See accompanying notes to the consolidated financial statements.
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QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ -------------------------
2000 2001 2000 2001
------- -------- -------- --------
Net loss ................................................ $(4,409) $(12,948) $(10,094) $(27,730)
Other comprehensive loss:
Unrealized loss on available-for-sale securities .... (60) (299) (515) (41)
------- -------- -------- --------
Comprehensive loss ...................................... $(4,469) $(13,247) $(10,609) $(27,771)
======= ======== ======== ========
See accompanying notes to the consolidated financial statements.
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QUEST SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
Quest Software, Inc., a California corporation (the "Company" or "Quest"), as of
June 30, 2001 and for the three and six months ended June 30, 2000 and 2001
reflect all adjustments (consisting of normal recurring accruals) which, 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 generally accepted accounting principles 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.
These financial statements should be read in conjunction with the
audited financial statements included in the Company's Annual Report on Form
10-K for the year ended December 31, 2000.
Operating results for the three and six months ended June 30, 2001 are
not necessarily indicative of the results that may be expected for the full year
ending December 31, 2001.
NEW ACCOUNTING PRONOUNCEMENTS:
In September 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133, as
amended, is effective for all fiscal years beginning after June 15, 2000, and
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. Under SFAS No. 133, certain contracts that were not formerly
considered derivatives may now meet the definition of a derivative which would
be required to be reported as assets or liabilities and carried at fair value.
The Company adopted SFAS No. 133 effective January 1, 2001. The adoption of SFAS
No. 133 did not have a significant impact on the financial position, results of
operations, or cash flows of the Company.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the pooling-of-
interests method. SFAS 141 also requires reclassification of certain other
identifiable assets to a separate financial statement line to the extent they
meet certain criteria. The Company does not believe that the adoption of SFAS
141 will have a significant impact on its financial statements, beyond the
potential reclassification of certain identifiable intangible assets.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets", which is effective for the Company in January of 2002.
SFAS No. 142 requires that goodwill and other intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually. The Company will continue to assess its recorded goodwill and other
intangible assets under current generally accepted accounting principles at each
reporting period until the standard is adopted. The adoption of SFAS No. 142 in
January of 2002 will substantially reduce charges to operations for goodwill
amortization and change the method for determining impairment. The effect on the
financial statements has not been determined. Currently, the Company's
amortization of goodwill and other intangible assets is approximately $15.0
million per quarter.
2. ACQUISITIONS
Operations of the companies acquired throughout fiscal 2000 are included
in the consolidated financial statements from the dates of acquisition. The six
months ended June 30, 2001 include actual results of these acquisitions. The pro
forma results of operations data for the same period of 2000 presented below
assume that the acquisitions had been made at the beginning of fiscal 2000, and
include amortization of goodwill and identified intangibles from that date. The
pro forma data is presented for informational purposes only, and is not
necessarily indicative of the results of future operations nor of the actual
results that would have been achieved had the acquisitions taken place at the
beginning of fiscal 2000 (in thousands):
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SIX MONTHS ENDED JUNE 30,
-----------------------------------
2000 2001
----------- --------------
(pro forma) (as reported)
Revenues $ 72,389 $ 129,973
Net loss (33,617) (27,730)
Net loss per share - basic and diluted $ (0.40) $ (0.32)
3. OTHER COMPENSATION COSTS
The Company records compensation expense for options to purchase the
Company's common stock granted with an exercise price below fair market value.
The expense equals the difference between the fair market value of the Company's
common stock on the grant date and the exercise price of the stock options and
is recognized ratably over the vesting period of the stock options, which is
currently four to five years. The following table shows the allocation to Cost
of Services Revenues, Sales and Marketing, Research and Development and General
and Administrative expenses of such costs based on the related headcount (in
thousands):
AS REPORTED ALLOCATION PRO FORMA
------------ ---------- ---------
Three months ended June 30, 2000
Cost of services revenues $ 2,252 $ 49 $ 2,301
Sales and marketing 16,962 310 17,272
Research and development 9,336 408 9,744
General and administrative 3,635 49 3,684
Three months ended June 30, 2001
Cost of services revenues $ 4,411 $ 61 $ 4,472
Sales and marketing 31,221 461 31,682
Research and development 15,457 399 15,856
General and administrative 6,086 102 6,188
Six months ended June 30, 2000
Cost of services revenues $ 4,122 $ 95 $ 4,217
Sales and marketing 30,876 568 31,444
Research and development 16,702 805 17,507
General and administrative 6,732 111 6,843
Six months ended June 30, 2001
Cost of services revenues $ 8,489 $ 122 $ 8,611
Sales and marketing 62,081 946 63,027
Research and development 29,387 916 30,303
General and administrative 12,439 1,069 13,508
4. NET LOSS PER SHARE
The Company computes net loss per share in accordance with SFAS No. 128,
Earnings per Share. Basic earnings per share is computed by dividing net loss by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of securities by including
other common
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stock equivalents, including stock options, 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
earnings per share calculations (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------
2000 2001 2000 2001
---------- ---------- -------- ---------
Shares used in computing basic net
income (loss) per share 85,526 87,520 83,351 87,267
Dilutive effect of stock options --(1) --(1) --(1) --(1)
------ ------ ------ ------
Shares used in computing diluted net
income (loss) per share 85,526 87,520 83,351 87,267
====== ====== ====== ======
- ----------
(1) Effect would have been anti-dilutive, accordingly, the amount is excluded
from shares used in computing diluted net loss per share. The dilutive
effect of stock options would have been 4,915 and 4,410 shares for the three
and six months ended June 30, 2001, respectively, compared to 5,922 and
6,098 shares for the same periods of 2000.
5. SHAREHOLDERS' EQUITY
In January 2001, approximately 94,000 shares of common stock were issued
under the Company's Employee Stock Purchase Plan at a price of $31.82 per share.
6. STOCK OPTION PLANS
The following table summarizes information about stock options
outstanding as of June 30, 2001 (in thousands, except for per share data):
Number of Options
Number of Weighted Average Exercisable as of
Shares Exercise Price June 30, 2001
------------ ------------------- -------------------
Balance at December 31, 2000 10,641 $ 12.72
Granted 5,010 16.55
Exercised (1,039) 4.08
Canceled (1,259) 17.45
------
Balance at June 30, 2001 13,353 $ 14.39 2,110
======
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7. OPERATING SEGMENT DATA
Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the Company's chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. The operating
segments of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.
The Company's reportable operating segments include Licenses and
Services. The Licenses segment develops and markets the Company's software
products. The Services segment provides after-sale support for software products
and fee-based training and consulting services related to the Company's
products.
The Company does not separately allocate operating expenses to these
segments, nor does it allocate specific assets to these segments. Therefore,
segment information reported includes only revenues, cost of revenues, gross
profit and income (loss) from operations, as this information and the geographic
information described below are the only information provided to the chief
operating decision maker on a segment basis.
Operating segment data for the three and six months ended June 30, 2000
and 2001 were as follows (in thousands):
LICENSES SERVICES TOTAL
-------- -------- --------
Three months ended June 30, 2000
Revenues $28,528 $ 8,126 $ 36,654
Cost of Revenues 1,971 2,252 4,223
------- ------- --------
Gross profit $26,557 $ 5,874 $ 32,431
======= ======= ========
Three months ended June 30, 2001
Revenues $49,158 $17,704 $ 66,862
Cost of Revenues 3,029 4,411 7,440
------- ------- --------
Gross profit $46,129 $13,293 $ 59,422
======= ======= ========
Six months ended June 30, 2000
Revenues $50,423 $14,956 $ 65,379
Cost of Revenues 3,263 4,122 7,385
------- ------- --------
Gross profit $47,160 $10,834 $ 57,994
======= ======= ========
Six months ended June 30, 2001
Revenues $97,587 $32,386 $129,973
Cost of Revenues 5,953 8,489 14,442
------- ------- --------
Gross profit $91,634 $23,897 $115,531
======= ======= ========
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Revenues are attributed to geographic areas based on the location of the
entity from which the products or services were sold. Revenues, gross profit,
income (loss) from operations and long-lived assets concerning principal
geographic areas in which the Company operates for the three and six months
ended June 30, 2000 and 2001, respectively, were as follows (in thousands):
NORTH OTHER
AMERICA(1) EUROPE INTERNATIONAL TOTAL
---------- -------- ------------- -----------
Three months ended June 30, 2000
Revenues $ 30,658 $ 5,216 $ 780 $ 36,654
Gross profit 29,372 2,717 342 32,431
Income (loss) from operations (3,778) 158 (1,913) (5,533)
Long-lived assets 175,555 674 1,212 177,441
Three months ended June 30, 2001
Revenues $ 54,241 11,635 986 $ 66,862
Gross profit 52,369 6,683 370 59,422
Loss from operations (3,617) (1,434) (3,760) (8,811)
Long-lived assets 277,176 1,862 1,445 280,483
Six months ended June 30, 2000
Revenues $ 54,375 $ 9,679 $ 1,325 $ 65,379
Gross profit 52,533 4,991 470 57,994
Income (loss) from operations (8,681) 538 (3,582) (11,725)
Long-lived assets 175,555 674 1,212 177,441
Six months ended June 30, 2001
Revenues $ 106,353 20,907 2,713 $ 129,973
Gross profit 102,520 11,755 1,256 115,531
Loss from operations (9,273) (3,874) (6,680) (19,827)
Long-lived assets 277,176 1,862 1,445 280,483
- ------------
(1) Principally represents operations in the United States.
8. INVESTMENTS
The Company has classified all debt securities with original maturities
of greater than three months as available-for-sale. Available-for-sale
securities are carried at fair value, with unrealized gains and losses reported
as a separate component of shareholders' equity net of applicable income taxes.
Realized gains and losses and declines in value judged to be other-than-
temporary on available-for-sale securities are included in other income. The
cost basis for realized gains and losses on available-for-sale securities is
determined on a specific identification basis. The Company has classified
available-for-sale securities as current or long-term based primarily on the
maturity date of the related securities.
The Company has certain other minority equity investments in
non-publicly traded companies. These investments are included in other assets on
the Company's consolidated balance sheet at June 30, 2001 and are carried at
cost. The Company monitors these investments for impairment and as a result
recorded a writedown of $1.5 million during the three months ended June 30,
2001.
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this report, including statements regarding the
Company's strategy, financial performance and revenue sources, are
forward-looking statements. These forward-looking statements are based on
current expectations and entail various risks and uncertainties that could cause
actual results to differ materially from those expressed in such forward-looking
statements. The Company's actual results could differ materially from the
results anticipated in these forward-looking statements as a result of certain
factors set forth under "Risk Factors" and elsewhere in this report. Readers are
urged to carefully review and consider the various disclosures made by the
Company in this report and in the Company's other reports filed with the SEC,
including the Company's Annual Report on Form 10-K for the year ended December
31, 2000, that attempt to advise interested parties of certain risks and factors
that may affect the Company's business. Readers are cautioned not to place undue
reliance on these forward-looking statements to reflect events or circumstances
occurring after the date hereof. The following discussion should be read in
conjunction with the Company's consolidated financial statements and notes
thereto. We do not assume any obligation to revise forward-looking statements.
OVERVIEW
We provide application management software solutions that enhance our
customers' return on IT investment dollars by maximizing availability, improving
performance, maximizing the effectiveness of IT personnel and improving the
quality of business critical applications. Our product families are designed to
meet the availability and performance requirements of our customers' most
critical applications. Each product family consists of an integrated suite of
software tools that enable personnel to manage and administer complex database
systems and business applications, both packaged and custom developed. These
applications can include ERP (enterprise resource planning) systems, CRM
(customer relationship management) systems, B2B (business to business)
e-commerce systems, corporate messaging and Internet and web-based applications.
We enable organizations to leverage IT infrastructure investments by maximizing
the performance and availability of enterprise applications with solutions for
High Availability, Application Monitoring, Database Management, SQL Development,
and Report Management.
We derive our revenues primarily from the sale of software licenses and
related annual maintenance fees. Pricing of our software licenses is generally
based on the number of servers, workstations and/or users of our products.
Services consist primarily of annual maintenance contracts for technical support
and product enhancements, and consulting services.
We recognize software license revenues when a non-cancelable license
agreement has been signed with a customer, delivery of the software has
occurred, the fees are fixed and determinable, no significant post-delivery
vendor obligations remain and collection is deemed probable. Maintenance
revenues are recognized ratably over the contract term, which is typically one
year. Revenues for consulting services are recognized as such services are
performed.
International revenues from licenses and services sold to customers
outside of North America were $6.0 million and $12.6 million for the three
months ended June 30, 2000 and 2001, respectively, and $11.0 million and $23.6
million for the six months ended June 30, 2000 and 2001, respectively. We intend
to expand our international sales activities as part of our business strategy.
All of our current international revenues are derived from the operations of our
wholly owned international subsidiaries, which consist of both direct sales and
sales through distributors. Our international subsidiaries conduct business in
the currency of the country in which they operate (with the exception of Mexico
and Brazil where the U.S. Dollar is used), exposing us to currency fluctuations
and currency transaction losses or gains which are outside of our control.
Historically, fluctuations in foreign currency exchange rates have not had a
material effect on our business. We have not, to date, conducted any hedging
transactions to reduce our risk to currency fluctuations.
In the development of new products and enhancements of existing
products, the technological feasibility of the software is not established until
substantially all product development is complete. Historically, our software
development costs eligible for capitalization have been insignificant, and all
costs related to internal research and development have been expensed as
incurred.
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RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of operations
data as a percentage of total revenues, except as indicated:
Three months ended Six months ended
June 30, June 30,
-------------------- --------------------
2000 2001 2000 2001
----- ----- ----- -----
Revenues:
Licenses 77.8% 73.5% 77.1% 75.1%
Services 22.2 26.5 22.9 24.9
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
Licenses 2.4 1.7 2.3 1.6
Services 6.1 6.6 6.3 6.5
Amortization of purchased intangible assets 3.0 2.8 2.7 3.0
----- ----- ----- -----
Total cost of revenues 11.5 11.1 11.3 11.1
----- ----- ----- -----
Gross profit 88.5 88.9 88.7 88.9
Operating expenses:
Sales and marketing 46.3 46.7 47.2 47.8
Research and development 25.5 23.1 25.5 22.6
General and administrative 9.9 9.1 10.3 9.6
Amortization of purchased intangible assets
and other compensation costs 21.9 23.1 23.6 24.2
----- ----- ----- -----
Total operating expenses 103.6 102.0 106.6 104.2
----- ----- ----- -----
Income (loss) from operations (15.1) (13.1) (17.9) (15.3)
Other income, net 10.0 2.6 7.1 2.7
Loss on equity investments - (2.2) - (1.1)
----- ----- ----- -----
Income (loss) before income tax provision (5.1) (10.5) (10.8) (12.6)
Income tax provision 6.9 6.6 4.6 7.6
----- ----- ----- -----
Net income (loss) (12.0)% (17.1)% (15.4)% (20.2)%
===== ===== ===== =====
As a percentage of related revenues:
Cost of licenses 3.1% 2.3% 3.0% 2.1%
Cost of services 27.5 24.9 27.5 26.1
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 2001
REVENUES
Total revenues for the three and six months ended June 30, 2001 were
$66.9 million and $130.0 million, respectively, an increase of 82.4% and 98.8%
from the comparable periods of 2000. Revenues outside of North America for the
three and six months ended June 30, 2001 were $12.6 million and $23.6 million,
respectively, an increase of 110.5% and 114.6% from the comparable periods of
2000.
LICENSES
Licenses for the three and six months ended June 30, 2001 were $49.2
million and $97.6 million, respectively, an increase of 69.9% and 93.5% from the
comparable periods of 2000. Licenses outside of North America accounted for
20.6% and 19.5% of total
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licenses for the three and six months ended June 30, 2001, respectively,
compared to 16.9% and 17.9% for the same periods in 2000. The increases in
licenses during the three and six month periods ended June 30, 2001 were due to
expansion of our worldwide sales force, as well as increased market acceptance
of our software products and availability of new products relative to the
comparable periods of 2000. New products include Quest Central for DB2 and a
variety of products for the Windows systems management market, as well as
LiveReorg and SQLab Vision for Oracle.
SERVICES
Services for the three and six months ended June 30, 2001 were $17.7
million and $32.4 million, respectively, an increase of 117.9% and 116.5% from
the comparable periods of 2000. Services revenues represented 26.5% and 24.9% of
total revenues for the three and six months ended June 30, 2001, respectively,
compared to 22.2% and 22.9% for the same periods of 2000. Services revenues
outside of North America accounted for 14.0% and 20.9% of total services for the
three and six months ended June 30, 2001, respectively, compared to 14.5% and
13.4% for the same periods in 2000. The increases in services during the three
and six month periods ended June 30, 2001 reflect an increase in the number of
software licenses sold with maintenance agreements and renewals of maintenance
agreements on existing licenses as well as the increase in consulting and
training services performed for customers.
COST OF REVENUES
COST OF LICENSES
Cost of licenses includes amortization of software licenses, product
media, printing and duplication costs, and royalties. Cost of licenses were $1.1
million and $2.0 million for the three and six months ended June 30, 2001,
respectively, versus $0.9 million and $1.5 million in the comparable periods of
2000. Cost of licenses as a percentage of license revenues were 2.3% and 2.1%
for the three and six months ended June 30, 2001, respectively, compared to 3.1%
and 3.0% for the same periods in 2000. The increase in cost of licenses was
principally the result of increases in royalties resulting from the growth in
sales of related products, partially offset by a decrease in printing and
duplication costs. The improvement in gross margin resulted from increased
license revenues without a corresponding increase in amortization of acquired
software licenses, which does not vary by the number of licenses sold.
COST OF SERVICES
Cost of services includes salaries and related costs for customer
support and consulting personnel. Cost of services for the three and six months
ended June 30, 2001 were $4.4 million and $8.5 million, respectively, versus
$2.3 million and $4.1 million for the comparable periods of 2000. Cost of
services as a percentage of services revenues were 24.9% and 26.1% for the three
and six months ended June 30, 2001, respectively, compared to 27.5% for the same
periods in 2000. The increase in cost of services is primarily due to the
increase in the number of technical support personnel required to manage and
support our growing customer base as well as increased product offerings. Our
gross margin on services revenues could fluctuate on a quarterly basis in the
future, reflecting the timing differences between increasing our organizational
investments and the corresponding revenue growth that we expect as a result. We
expect the cost of services to increase in absolute dollars for the foreseeable
future as additional customer support and consulting personnel are hired.
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AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
Amortization of purchased intangible assets was $1.9 million and $3.9
million during the three and six months ended June 30, 2001, respectively,
versus $1.1 million and $1.8 million in the same periods of 2000. This increase
was due entirely to amortization of technology purchased as part of the
acquisitions made during the second and third quarters of 2000. The useful lives
of the technology acquired range from one to three years, and we expect the
amortization to be at least $1.0 million over the next eight quarters.
OPERATING EXPENSES
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, commissions
earned by sales personnel, recruiting costs, trade shows, travel and
entertainment, and other marketing communications costs such as advertising and
promotion. Sales and marketing expenses were $31.2 million and $62.1 million for
the three and six months ended June 30, 2001, respectively, versus $17.0 million
and $30.9 million for the comparable periods of 2000, representing increases of
84.1% and 101.1%, respectively. Sales and marketing expenses as a percentage of
total revenues were 46.7% and 47.8% for the three and six months ended June 30,
2001, respectively, compared to 46.3% and 47.2% in the same periods of 2000. The
increases reflect our investment in our sales and marketing organization. In
particular, sales and marketing employees increased from 414 as of June 30, 2000
to 706 as of June 30, 2001, an increase of 71%. We intend to enhance our sales
and marketing infrastructure during 2001 and, as a result, expect sales and
marketing expenses to increase in absolute dollars.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and
benefits for software developers, software product managers, quality assurance
personnel, and payments made to outside software development contractors.
Research and development expenses were $15.5 million and $29.4 million for the
three and six months ended June 30, 2001, respectively, versus $9.3 million and
$16.7 million in the same periods of 2000, representing increases of 65.6% and
75.9%, respectively. These expenses as a percentage of total revenues were 23.1%
and 22.6% for the three and six months ended June 30, 2001, respectively,
compared to 25.5% in the same periods of 2000. The increase in research and
development expenses was due to investments in research and development efforts,
including the increase in the number of software developers and quality
assurance personnel. Research and development headcount increased from 383 as of
June 30, 2000 to 595 as of June 30, 2001, an increase of 55.4%. We believe
significant expenditures in research and development are required to remain
competitive, and expect that research and development expenses will continue to
represent 20-25% of total revenues.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of salaries,
benefits and related costs for our executive, finance, administrative and
information services personnel. General and administrative expenses were $6.1
million and $12.4 million for the three and six months ended June 30, 2001,
respectively, versus $3.6 million and $6.7 million in the same periods of 2000,
representing increases of 67.4% and 84.8%, respectively. These expenses as a
percentage of total revenues were 9.1% and 9.6% for the three and six months
ended June 30, 2001, respectively, compared to 9.9% and 10.3% in the same
periods of 2000. The increase in general and administrative expenses was
primarily due to the increase in headcount to support our growing infrastructure
and expanding operations. General and administrative headcount increased from
119 as of June 30, 2000 to 207 as of June 30, 2001, an increase of 73.9%. As a
result, salaries and related costs increased $3.5 million for the six months
ended June 30, 2001 over the same period of 2000. We expect that general and
administrative expenses will continue to increase in absolute dollars as we
continue to enhance our infrastructure and support expansion of our operations.
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OTHER COMPENSATION COSTS AND INTANGIBLE AMORTIZATION
Other compensation costs and intangible amortization include
compensation expense associated with the issuance (primarily in 1999) of stock
options below fair market value and the amortization of goodwill and other
intangible assets associated with acquisitions. These costs totaled $15.5
million and $31.5 million for the three and six months ended June 30, 2001,
respectively, compared to $8.0 million and $15.4 million in the same periods of
2000. These expenses as a percentage of total revenues were 23.1% and 24.2% for
the three and six months ended June 30, 2001, respectively, compared to 21.9%
and 23.6% in the same periods of 2000. The increase in these costs was due to
the acquisitions made during the second and third quarters of 2000. The adoption
of SFAS No. 142 in January of 2002 will substantially reduce charges to
operations for goodwill amortization and change the method for determining
impairment. The effect on the financial statements has not been determined.
Currently, the Company's amortization of goodwill and other intangible assets is
approximately $15.0 million per quarter.
OTHER INCOME, NET
Other income, net was $1.7 million and $3.5 million for the three and
six months ended June 30, 2001, respectively, compared to $3.7 million and $4.6
million for the same periods of 2000, representing a decrease of 54.1% and
23.9%, respectively. The decrease is due primarily to less interest income
earned in the three months ended June 30, 2001 versus the same period in 2000.
The decrease in interest earned is a result of lower cash balances from
application of net proceeds from the secondary public offering in March 2000
including acquisitions completed during 2000, which a portion of the purchase
price was cash and the stock repurchases made during the fourth quarter of 2000.
LOSSES ON EQUITY INVESTMENTS
During the second quarter of 2001 we wrote down the carrying value of
certain equity investments by $1.5 million as a one-time charge to reflect their
estimated carrying value. The remaining equity investments of $6.7 million are
included in other assets on the Company's consolidated balance sheet at June 30,
2001.
PROVISION FOR INCOME TAXES
Provision for income taxes was $4.4 million and $9.9 million for the
three and six months ended June 30, 2001, respectively, compared with $2.5
million and $3.0 million for the same periods of 2000, representing effective
rates of (51.2)% and (55.8)%, for the three and six months ended June 30, 2001,
respectively, compared to (136.0)% and (42.6)% in the same periods of 2000.
Excluding non-deductible amortization of intangible assets and other
compensation costs, our effective income tax rate was 40% for the three and six
months ended June 30, 2000 and 2001.
INFLATION
Inflation has not had a significant effect on our results of operations
or financial position for the three and six months ended June 30, 2001 or the
comparable periods of 2000.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our business, to date, primarily from cash generated by
our operations, net proceeds of $64.9 million from our initial public offering
in August 1999, and net proceeds of $253.5 million from our secondary offering
in March 2000. Our sources of liquidity as of June 30, 2001 consisted
principally of cash and cash equivalents of $68.5 million and $108.7 million in
short- and long-term high grade corporate and government marketable securities.
Net cash provided by operating activities was $33.1 million for the six
months ended June 30, 2001, compared with $8.6 million for the comparable period
in 2000. The increase in 2001 is primarily due to higher non-cash depreciation
and amortization expenses as a result of increased amortization of goodwill and
other intangible assets, which increased by $17.0 million, a 114.8% increase
over the comparable period of 2000. Increases in deferred revenue and income
taxes payable, offset by net losses also contributed to the increase in 2001.
Investing activities used $218.9 million and provided $3.4 million
during the six months ended June 30, 2000 and 2001, respectively. The decrease
in 2001 is due to purchases of marketable securities made in March of 2000 as a
result of our secondary public offering as well as acquisitions made during the
first and second quarter of 2000 with dissimilar activity in 2001. Investing
activities for the six months ended June 30, 2001 provided cash as a result of
sales and maturities of marketable securities offset by purchases of property
and equipment.
Financing activities provided $253.9 million and $6.7 million for the
six months ended June 30, 2000 and 2001, respectively. The decrease is primarily
due to proceeds of $253.5 million received from the secondary public
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offering in March 2000. Offsetting this decrease were increases in proceeds from
the exercise of stock options and our employee stock purchase plan during 2001.
We believe that our existing cash, cash equivalents and investment
balances and cash flows from operations will be sufficient to finance our
working capital and capital expenditure requirements through at least the next
12 months. We may require additional funds to support our working capital
requirements or for other purposes, and may seek to raise additional funds
through public or private equity or debt financing, or from other sources. If
additional financing is needed, we cannot assure you that such financing will be
available to us at commercially reasonable terms or at all.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133, as
amended, is effective for all fiscal years beginning after June 15, 2000, and
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. Under SFAS 133, certain contracts that were not formerly
considered derivatives may now meet the definition of a derivative which would
be required to be reported as assets or liabilities and carried at fair value.
The Company adopted SFAS 133 effective January 1, 2001. The adoption of SFAS No.
133 did not have a significant impact on the financial position, results of
operations, or cash flows of the Company.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the pooling-of-
interests method. SFAS 141 also requires reclassification of certain other
identifiable assets to a separate financial statement line to the extent they
meet certain criteria. The Company does not believe that the adoption of SFAS
141 will have a significant impact on its financial statements, beyond the
potential reclassification of certain identifiable intangible assets.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets", which is effective for the Company in January of 2002.
SFAS No. 142 requires that goodwill and other intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually. The Company will continue to assess its recorded goodwill and other
intangible assets under current generally accepted accounting principles at each
reporting period until the standard is adopted. The adoption of SFAS No. 142 in
January of 2002 will substantially reduce charges to operations for goodwill
amortization and change the method for determining impairment. The effect on the
financial statements has not been determined. Currently, the Company's
amortization of goodwill and other intangible assets is approximately $15.0
million per quarter.
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RISK FACTORS
An investment in our shares involves risks and uncertainties. You should
carefully consider the factors described below before making an investment
decision in our securities. The risks described below are the risks that we
currently believe are material risks of business and the industry in which we
compete.
Our business, financial condition and results of operations could be
adversely affected by any of the following risks. If we are adversely affected
by such risks, then the trading price of our common stock could decline, and you
could lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS AND, AS A
RESULT, WE MAY FAIL TO MEET EXPECTATIONS OF INVESTORS AND ANALYSTS, CAUSING OUR
STOCK PRICE TO FLUCTUATE OR DECLINE
Our revenues and operating results may vary significantly from quarter
to quarter due to a number of factors. These factors include the following:
- the size and timing of customer orders. See "-- The size and timing of
our customer orders may vary significantly from quarter to quarter which
could cause fluctuations in our revenues."
- the unpredictability of the timing and level of sales through our
indirect sales channel;
- the timing of revenue recognition for sales of software products and
services;
- the extent to which our customers renew their maintenance contracts with
us;
- the possibility that our customers may cancel or defer purchases as a
result of reduced IT budgets or in anticipation of new products or
product updates by us or by our competitors;
- the possibility of an economic slowdown generally;
- the amount and timing of expenditures related to expansion of our
operations;
- our ability to attain market acceptance of new products and services and
enhancements to our existing products;
- lack of order backlog;
- changes in our pricing policies or the pricing policies of our
competitors;
- the relative growth rates of the Windows NT and UNIX markets, as well as
the rate of adoption of Microsoft's release of Windows 2000 by users;
- costs related to acquisitions of technologies or businesses, including
amortization of goodwill and other intangible assets; and
- the timing of releases of new versions of third-party software products
that our products support.
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Fluctuations in our results of operations are likely to affect the
market price of our common stock that may not be related to our long-term
performance.
THE SIZE AND TIMING OF OUR CUSTOMER ORDERS MAY VARY SIGNIFICANTLY FROM QUARTER
TO QUARTER WHICH COULD CAUSE FLUCTUATIONS IN OUR REVENUES
In any given quarter, sales of some of our products have involved large
financial commitments from a relatively small number of customers, and
cancellation or deferral of these large contracts would reduce our revenues. In
addition, the sales cycles for certain of our software products, such as Vista
Plus and SharePlex, can last from three to nine months and often require
pre-purchase evaluation periods and customer education. These relatively long
sales cycles may cause significant periodic variation in our license revenues.
Also, we have often booked a large amount of our sales in the last month or
weeks of each quarter and delays in the closing of sales near the end of a
quarter could cause quarterly revenue to fall short of anticipated levels.
Finally, while a portion of our revenues each quarter is recognized from
previously deferred revenue, our quarterly performance will depend primarily
upon entering into new contracts to generate revenues for that quarter.
MANY OF OUR PRODUCTS ARE DEPENDENT ON ORACLE'S TECHNOLOGIES; IF ORACLE'S
TECHNOLOGIES LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS, THE
DEMAND FOR OUR PRODUCTS COULD SUFFER
We believe that our success has depended in part, and will continue to
depend in part for the foreseeable future, upon our relationship with Oracle and
our status as a complementary software provider for Oracle's database and
application products. Many versions of our products, including SharePlex, SQLab
Vision, and SQL Navigator, are specifically designed to be used with Oracle
databases. Although a number of our products work with other environments, our
competitive advantage consists in substantial part on the integration between
our products and Oracle's products, and our extensive knowledge of Oracle's
technology. Currently, a significant portion of our total revenues are derived
from products that specifically support Oracle-based products. If Oracle for any
reason decides to promote technologies and standards that are not compatible
with our technology, or if Oracle loses market share for its database products,
our business, operating results and financial condition would be materially
adversely affected.
MANY OF OUR PRODUCTS ARE VULNERABLE TO DIRECT COMPETITION FROM ORACLE
We currently compete with Oracle in the market for database management
solutions. We expect that Oracle's commitment to and presence in the database
management product market will increase in the future and therefore
substantially increase competitive pressures. We believe that Oracle will
continue to incorporate database management technology into its server software
offerings, possibly at no additional cost to its users. We believe that Oracle
will also continue to enhance its database management technology. Furthermore,
Oracle could attempt to increase its presence in this market by acquiring or
forming strategic alliances with our competitors, and Oracle may be in better
position to withstand and respond to the current factors impacting this
industry. Oracle has a longer operating history, a larger installed base of
customers and substantially greater financial, distribution, marketing and
technical resources than we do. In addition, Oracle has well-established
relationships with many of our present and potential customers. As a result, we
may not be able to compete effectively with Oracle in the future, which could
materially adversely affect our business, operating results and financial
condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW AND ENHANCED PRODUCTS THAT
ACHIEVE WIDESPREAD MARKET ACCEPTANCE
Our future success depends on our ability to address the rapidly
changing needs of our customers by developing and introducing new products,
product updates and services on a timely basis, by extending the operation of
our products on new platforms and by keeping pace with technological
developments and emerging industry standards. In order to grow our business, we
are committing substantial resources to developing software products and
services for the applications management market. If this market does not
continue to develop as anticipated, or demand for our products in this market
does not materialize or occurs more slowly than we expect, or if our development
efforts are delayed or unsuccessful, we will have expended substantial resources
and capital without realizing sufficient revenues, and our business and
operating results could be adversely affected.
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ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR
BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION
We have in the past made and we expect to continue to make acquisitions
of complementary companies, products or technologies. If we make any additional
acquisitions, we will be required to assimilate the operations, products and
personnel of the acquired businesses and train, retain and motivate key
personnel from the acquired businesses. We may be unable to maintain uniform
standards, controls, procedures and policies if we fail in these efforts.
Similarly, acquisitions may subject us to liabilities and risks that are not
known or identifiable at the time of the acquisition or may cause disruptions in
our operations and divert management's attention from day-to-day operations,
which could impair our relationships with our current employees, customers and
strategic partners. We may have to incur debt or issue equity securities to pay
for any future acquisitions. The issuance of equity securities for any
acquisition could be substantially dilutive to our shareholders. In addition,
our profitability may suffer because of acquisition-related costs or
amortization costs for acquired goodwill and other intangible assets. In
consummating acquisitions, we are also subject to risks of entering geographic
and business markets in which we have no or limited prior experience. If we are
unable to fully integrate acquired businesses, products or technologies with our
existing operations, we may not receive the intended benefits of acquisition.
OUR ABILITY TO INCREASE OUR REVENUES DEPENDS ON OUR ABILITY TO EXPAND OUR
INDIRECT SALES CHANNELS
We intend to aggressively pursue expansion of our indirect sales
channels through arrangements with resellers, systems integrators and
distributors. In certain domestic and international markets we may miss sales
opportunities if we are unable to enter into successful relationships with
locally based resellers. We may become more dependent on these type of
relationships. There can be no assurance that we will successfully develop these
relationships or that the expansion of indirect sales distribution methods will
increase revenues.
OUR PAST AND FUTURE GROWTH MAY STRAIN OUR MANAGEMENT, ADMINISTRATIVE,
OPERATIONAL AND FINANCIAL INFRASTRUCTURE
We have recently experienced a period of rapid growth in our operations
that has placed and will continue to place a strain on our management,
administrative, operational and financial infrastructure. During this period, we
have experienced an increase in the number of our employees, increasing demands
on our operating and financial systems and personnel, and an expansion in the
geographic coverage of our operations. Our ability to manage our operations and
growth requires us to continue to improve our operational, financial and
management controls, and reporting systems and procedures. We may need to expand
our facilities or relocate some or all of our employees or operations from time
to time to support growth. These relocations could result in temporary
disruptions of our operations or a diversion of management's attention and
resources. In addition, we will be required to hire additional management,
financial and sales and marketing personnel to manage our expanding operations.
If we are unable to manage this growth effectively, our business, operating
results and financial condition may be materially adversely affected.
WE MAY NOT GENERATE INCREASED BUSINESS FROM OUR CURRENT CUSTOMERS, WHICH COULD
SLOW OUR REVENUE GROWTH IN THE FUTURE
Most of our customers initially make a purchase of our products for a
single department or location. Many of these customers may choose not to expand
their use of our products. If we fail to generate expanded business from our
current customers, our business, operating results and financial condition could
be materially adversely affected. In addition, as we deploy new modules and
features for our existing products or introduce new products, our current
customers may choose not to purchase this new functionality or these new
products. Moreover, if customers elect not to renew their maintenance
agreements, our service revenues would be materially adversely affected.
WE EXPECT TO INCUR SIGNIFICANT INCREASES IN OUR OPERATING EXPENSES IN THE
FORESEEABLE FUTURE, WHICH MAY AFFECT OUR FUTURE PROFITABILITY
We intend to substantially increase our operating expenses for the
foreseeable future as we continue to:
- increase our sales and marketing activities, including expanding our
direct sales and telesales forces;
- increase our research and development activities;
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- expand our general and administrative activities; and
- expand our customer support organizations.
Accordingly, we will be required to significantly increase our revenues
in order to maintain profitability. These expenses will be incurred before we
generate any revenues by this increased spending. If we do not significantly
increase revenues from these efforts, our business and operating results would
be negatively impacted.
OUR INTERNATIONAL OPERATIONS AND OUR PLANNED EXPANSION OF OUR INTERNATIONAL
OPERATIONS EXPOSES US TO CERTAIN RISKS
Substantially all of our current international revenues are derived from
the operations of three of our wholly-owned subsidiaries in Australia, the
United Kingdom and Germany. Revenues from licenses and services to customers
outside of North America were $15.3 million in 1999 (representing 21.6% of total
revenues), $28.7 million in 2000 (representing 17.3% of total revenues), and
$12.6 and $23.6 in the three and six month periods ended June 30, 2001,
respectively, versus $6.0 and $11.0 in the same periods of 2000 (representing
18.9% and 18.2% of total revenues in 2001, respectively, and 16.4% and 17.3% in
the same periods of 2000). As a result, we face increasing risks from doing
business on an international basis, including, among others:
- difficulties in staffing and managing foreign operations;
- longer payment cycles;
- seasonal reductions in business activity in Europe;
- increased financial accounting and reporting burdens and complexities;
- potentially adverse tax consequences;
- potential loss of proprietary information due to piracy, misappropriation
or weaker laws regarding intellectual property protection;
- delays in localizing our products;
- compliance with a wide variety of complex foreign laws and treaties; and
- licenses, tariffs and other trade barriers.
In addition, because our international subsidiaries conduct business in
the currency of the country in which they operate, we are subject to currency
fluctuations and currency transaction losses or gains which are outside of our
control.
We plan to expand our international operations as part of our business
strategy. The expansion of our existing international operations and entry into
additional international markets will require significant management attention
and financial resources and will place additional burdens on our management,
administrative, operational and financial infrastructure. We cannot be certain
that our investments in establishing facilities in other countries will produce
desired levels of revenue or profitability. In addition, we have sold our
products internationally for only a few years and we have limited experience in
developing localized versions of our products and marketing and distributing
them internationally. As our international operations expand, our exposure to
exchange rate fluctuations will increase as we use an increasing number of
foreign currencies. We have not yet entered into any hedging transactions to
date to mitigate our expense to currency fluctuations.
OUR RECENTLY-IMPLEMENTED STRATEGY OF INVESTING IN DEVELOPMENT-STAGE COMPANIES
INVOLVES A NUMBER OF RISKS AND UNCERTAINTIES
We have and may continue to make investments in development-stage
companies that we believe provide strategic opportunities for Quest. Each of
these investments involves a number of risks and uncertainties, including
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diversion of management attention, inability to identify strategic
opportunities, inability to value investments appropriately, inability to manage
investments effectively and loss of cash invested. We intend that these
investments will complement our own research and development efforts, provide
access to new technologies and emerging markets, and create opportunities for
additional sales of our products and services. However, we cannot assure you
that this initiative will have the above mentioned desired results, or even that
we will not lose all or any part of these investments.
FAILURE TO DEVELOP STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS BY DENYING US
SELLING OPPORTUNITIES AND OTHER BENEFITS
Our current collaborative relationships may not prove to be beneficial
to us, and they may not be sustained. We also may not be able to enter into
successful new strategic relationships in the future, which could have a
material adverse effect on our business, operating results and financial
condition. From time to time, we have collaborated with other companies,
including Hewlett-Packard and Oracle and certain of the national accounting
firms that provide system integration services, in areas such as product
development, marketing, distribution and implementation. We could lose sales
opportunities if we fail to work effectively with these parties. Moreover, we
expect that maintaining and enhancing these and other relationships will become
a more meaningful part of our business strategy in the future. However, many of
our current partners are either actual or potential competitors with us. In
addition, many of these third parties also work with competing software
companies and we may not be able to maintain these existing relationships, due
to the fact that these relationships are informal or, if written, are terminable
with little or no notice.
OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED, AND THERE IS RISK OF
INFRINGEMENT CLAIMS OR INDEPENDENT DEVELOPMENT OF COMPETING TECHNOLOGY THAT
COULD HARM OUR COMPETITIVE POSITION
Our success and ability to compete are dependent on our ability to
develop and maintain the proprietary aspects of our technology. We rely on a
combination of trademark, trade secret, copyright law and contractual
restrictions to protect the proprietary aspects of our technology.
Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. Litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade
secrets, and to determine the validity and scope of the proprietary rights of
others. Any such resulting litigation could result in substantial costs and
diversion of resources.
Our means of protecting our proprietary rights may prove to be
inadequate and competitors may independently develop similar or superior
technology. Policing unauthorized use of our products is difficult, and we
cannot be certain that the steps we have taken will prevent misappropriation of
our technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. We also believe that,
because of the rapid rate of technological change in the software industry,
trade secret and copyright protection are less significant than factors such as
the knowledge, ability and experience of our employees, frequent product
enhancements and the timeliness and quality of customer support services.
Our success and ability to compete are also dependent on our ability to
operate without infringing upon the proprietary rights of others. Third parties
may claim infringement by us of their intellectual property rights. In the event
of a successful claim of product infringement against us and our failure or
inability to either license the infringed or similar technology or develop
alternative technology on a timely basis, we may incur substantial licensing
fees, be liable for infringement damage, or be unable to market our products.
OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS ERRORS
The software products we offer are inherently complex. Despite testing
and quality control, we cannot be certain that errors will not be found in
current versions, new versions or enhancements of our products after
commencement of commercial shipments. Significant technical challenges also
arise with our products because our customers purchase and deploy our products
across a variety of computer platforms and integrate it with a number of
third-party software applications and databases. If new or existing customers
have difficulty deploying our products or require significant amounts of
customer support, our operating margins could be harmed. Moreover, we could face
possible claims and higher development costs if our software contains undetected
errors or if we fail to meet our customers' expectations. As a result of the
foregoing, we could experience:
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- loss of or delay in revenues and loss of market share;
- loss of customers;
- damage to our reputation;
- failure to achieve market acceptance;
- diversion of development resources;
- increased service and warranty costs;
- legal actions by customers against us which could, whether or not
successful, increase costs and distract our management; and
- increased insurance costs.
In addition, a product liability claim, whether or not successful, could
harm our business by increasing our costs and distracting our management.
WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR PRODUCTS
AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY
SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE DEMAND FOR, OR
PREVENT THE SHIPPING OF, OUR PRODUCTS
Certain of our software products contain components developed and
maintained by third-party software vendors. We expect that we may have to
incorporate software from third-party vendors in our future products. We may not
be able to replace the functionality provided by the third-party software
currently offered with our products if that software becomes obsolete, defective
or incompatible with future versions of our products or is not adequately
maintained or updated. Any significant interruption in the availability of these
third-party software products or defects in these products could harm our sales
unless and until we can secure an alternative source. Although we believe there
are adequate alternate sources for the technology licensed to us, such alternate
sources may not provide us with the same functionality as that currently
provided to us.
NATURAL DISASTERS OR POWER OUTAGES COULD DISRUPT OUR BUSINESS
A substantial portion of our operations are located in California, and
we are subject to risks of damage and business disruptions resulting from
earthquakes, floods and similar events, as well as from power outages. We have
recently experienced limited and temporary power losses in our California
facilities due to power shortages, and we expect in the future to experience
additional power losses. While the impact to our business and operating results
has not been material, we cannot assure you that power losses will not adversely
affect our business in the future, or that the cost of acquiring sufficient
power to run our business will not increase significantly. Since we do not have
sufficient redundancy in our networking infrastructure, a natural disaster or
other unanticipated problem could have an adverse effect on our business,
including both our internal operations and our ability to communicate with our
customers or sell and deliver our products.
RISKS RELATED TO OUR INDUSTRY
THE DEMAND FOR OUR PRODUCTS WILL DEPEND ON OUR ABILITY TO ADAPT TO RAPID
TECHNOLOGICAL CHANGE
Our future success will depend on our ability to continue to enhance our
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments and satisfy increasingly
sophisticated customer requirements. Rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer demands and evolving industry standards characterize the market for
our products. The introduction of products embodying new technologies and the
emergence of new industry standards can render our existing products obsolete
and unmarketable. As a result of the complexities inherent in today's computing
environments and the performance demanded by customers for
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embedded databases and Web-based products, new products and product enhancements
can require long development and testing periods. As a result, significant
delays in the general availability of such new releases or significant problems
in the installation or implementation of such new releases could have a material
adverse effect on our business, operating results and financial condition. We
may not be successful in:
- developing and marketing, on a timely and cost-effective basis, new
products or new product enhancements that respond to technological
change, evolving industry standards or customer requirements;
- avoiding difficulties that could delay or prevent the successful
development, introduction or marketing of these products; or
- achieving market acceptance for our new products and product
enhancements.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN PERSONNEL
Our future success depends on the continued service of our executive
officers and other key administrative, sales and marketing and support
personnel, many of whom have recently joined our company. In addition, the
success of our business is substantially dependent on the services of our Chief
Executive Officer and our President and Chief Technical Officer. We intend to
hire a significant number of additional sales, support, marketing,
administrative and research and development personnel over at least the next 12
months. There has in the past been and there may in the future be a shortage of
personnel that possess the technical background necessary to sell, support and
develop our products effectively. Competition for skilled personnel is intense,
and we may not be able to attract, assimilate or retain highly qualified
personnel in the future. Our business may not be able to grow if we cannot
attract qualified personnel. Hiring qualified sales, marketing, administrative,
research and development and customer support personnel is very competitive in
our industry, particularly in Southern California where Quest is headquartered.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
FOREIGN CURRENCY HEDGING INSTRUMENTS
We transact business in various foreign currencies. Accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
This exposure is primarily related to revenues and operating expenses in Canada,
the United Kingdom, Germany, and Australia denominated in the respective local
currency.
To date, we have not used hedging contracts to hedge our
foreign-currency fluctuation risks. We will assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis. We also do not use
derivative financial instruments for speculative trading purposes.
INTEREST RATE RISK
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. We have not used derivative financial
instruments in our investment portfolio. We place our investments with
high-quality issuers and, by policy, limit the amount of credit exposure to any
one issuer. Our investments in marketable securities consist primarily of
high-grade corporate and government securities with maturities of less than two
years. Investments purchased with an original maturity of three months or less
are considered to be cash equivalents. We classify all of our investments as
available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of shareholders' equity. At June 30, 2001, the net gain on available-for-sale
securities of $0.1 million comprised 38 positions, of which 30 carry unrealized
gains and 8 carry unrealized losses.
The following table provides information about our investment portfolio
at June 30, 2001 (dollars in thousands):
Cash and cash equivalents $ 68,526
Average interest rate 4.96%
Short-term marketable securities $ 37,106
Average interest rate 6.74%
Long-term marketable securities $ 71,608
Average interest rate 5.31%
Total portfolio $177,240
Average interest rate 5.47%
We consider the carrying value of our investment securities to
approximate their fair value due to the relatively short period of time between
origination of the investments and their expected realization. We also maintain
a level of cash and cash equivalents such that we have generally been able to
hold our investments to maturity. Accordingly, changes in the market interest
rate would not have a material effect on the fair value of such investments.
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PART II
OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company's Annual Meeting of Shareholders was held on May 30,
2001.
(b) Proxies for the Annual Meeting were solicited pursuant to
Regulation 14 under the Securities Exchange Act of 1934, as amended, there
was no solicitation in opposition to the management's nominees as listed in
the proxy statement, and all of such nominees were elected.
(c) At the Annual Meeting, our shareholders elected Vincent C. Smith,
David M. Doyle, Doran G. Machin, Jerry Murdock, Jr. and Raymond J. Lane as
directors, approved a proposal to increase the minimum authorized number of
directors to four and ratified the appointment of Deloitte & Touche LLP as
independent auditors of the Company for the fiscal year ending December 31,
2001. Set forth below are the number of votes cast for, against or abstain,
as to each matter (there were no broker non-votes).
(1) Election of Directors:
Nominee For Against Abstain
------- --- ------- ---------
Vincent C. Smith 67,245,840 0 8,997,122
David M. Doyle 67,614,080 0 8,628,882
Doran Machin 75,431,604 0 811,358
Jerry Murdock, Jr. 75,996,057 0 246,905
Raymond J. Lane 75,965,464 0 277,498
(2) Increase to minimum number of authorized Directors:
For Against Abstain
--- ------- -------
75,355,720 883,173 4,069
(3) Ratification of Appointment of Deloitte & Touche LLP:
For Against Abstain
--- ------- -------
76,233,243 5,015 4,704
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.4 Certificate of Amendment of Bylaws
(b) REPORTS ON FORM 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
QUEST SOFTWARE, INC.
August 14, 2001 /s/ M. Brinkley Morse
------------------------------------
M. Brinkley Morse
Vice President, Finance and Operations
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EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
3.4 Certificate of Amendment of Bylaws.