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                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-K


[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934


                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                                       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

        Securities Registered Pursuant to Section 12(b) of the Act: ____

                 Securities Registered Pursuant to Section 12(g)
                     of the Act: common stock, no par value

        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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]


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        Based on the closing sale price on the Nasdaq National Market on March
17, 2000, the aggregate market value of the voting stock held by nonaffiliates
of the Registrant was $3,925,349,004. For the purposes of this calculation,
shares owned by officers, directors and 10% shareholders known to the Registrant
have been deemed to be owned by affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the Registrant's Common Stock, no par value,
as of March 17, 2000 was 42,631,683.

                       DOCUMENTS INCORPORATED BY REFERENCE

        Part III incorporates certain information by reference from the
Registrant's definitive proxy statement (the "Proxy Statement") for the Annual
Meeting of Shareholders scheduled to be held on May 16, 2000.



<PAGE>   3

                              QUEST SOFTWARE, INC.
                           ANNUAL REPORT ON FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1999

                                TABLE OF CONTENTS

<TABLE>
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                                                                                                 PAGE NUMBER
                                                                                                 -----------
                                     PART I

<S>                                                                                               <C>
Item 1.  Business.............................................................................       2
Item 2.  Properties...........................................................................       9
Item 3.  Legal Proceedings....................................................................       9
Item 4.  Submission of Matters to a Vote of Security Holders..................................       9

                                     PART II

Item 5.  Market for the Registrant's Common Equity and Related
               Shareholder Matters............................................................      10
Item 6.  Selected Financial Data..............................................................      12
Item 7.  Management's Discussion and Analysis of Financial Condition
               and Results of Operations......................................................      13
Item 7a. Quantitative and Qualitative Disclosures About Market Risk...........................      23
Item 8.  Financial Statements and Supplementary Data..........................................      23
Item 9.  Changes in and Disagreements With Accountants on Accounting
               and Financial Disclosures......................................................      23

                                    PART III

Item 10. Directors and Executive Officers of the Registrant...................................      24
Item 11. Executive Compensation...............................................................      24
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................      24
Item 13. Certain Relationships and Related Transactions.......................................      24

                                     PART IV

Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K......................      25

Signatures
</TABLE>

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                                               PART I

FORWARD-LOOKING INFORMATION

        Some of the matters discussed under the captions "Business," "Risk
Factors," and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" include or may include forward-looking statements within
the meaning of the federal securities laws. We have based these forward-looking
statements on currently available information and our current beliefs,
expectations and projections about future events, including, among other things,

    -   successfully implementing our business strategy;

    -   maintaining and expanding market acceptance of the products we offer;
        and

    -   our ability to successfully compete in our marketplace.

        In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "potential," "continue," "expects,"
"anticipates," "intends," "plans," "believes," "estimates" and similar
expressions. All forward-looking statements contained herein are subject to
numerous risks and uncertainties. Our actual results and the timing of certain
events could differ materially from those projected in the forward looking
statements due to a number of factors discussed under the heading "risk Factors"
in this Report and in our other filings with the Securities and Exchange
Commission, including but not limited to those discussed under the heading "Risk
Factors" in our Registration Statement on Form S-1 (File No. 333-30816). Should
one or more of these risks or uncertainties materialize, or should the
underlying estimates or assumptions prove incorrect, actual results or outcomes
may vary significantly from those anticipated, believed, estimated, expected,
intended or planned.

ITEM 1. BUSINESS

OVERVIEW

        We provide application and information availability software solutions
that enhance the performance and reliability of an organization's e-business,
enterprise and custom applications and enable the delivery of information across
the entire enterprise. Our application availability products are designed to
help ensure uninterrupted and high performance access to software systems by
utilizing a number of integrated products that enhance the performance of
applications and the underlying database which stores an enterprise's critical
information. Other primary components of our application availability solution
include our database products that maintain a real-time copy of a database for
offloading critical systems and assuring high availability, as well as our
products that manage the complex and error-prone process of development and
deployment of rapidly changing applications. Our information availability
products deliver an enterprise, report-based information management solution
that captures, manages and distributes report data or electronic documents from
virtually any application for instant distribution over intranets or the
Internet.

INDUSTRY BACKGROUND

        Organizations are constantly seeking ways to use information and
technology to gain competitive advantages. To compete more effectively,
organizations must deliver relevant information and provide increasingly
sophisticated and time-sensitive services to a rapidly expanding audience,
including employees, customers, suppliers and partners both inside and outside
of the traditional enterprise. Today, a growing number of organizations are
using the Internet to conduct business electronically. In embracing this
e-business model, enterprises are attempting to maximize the value of their
information technology infrastructure as they extend their business over the
Internet to directly reach a large number of geographically dispersed end-users.
The fundamental changes brought on by the increasing reliance on information
technology, including today's rapidly expanding e-business initiatives, are
introducing new complexities and transforming business practices:

    -   Decisions need to be made in real-time by personnel at all levels both
        inside and outside the enterprise;

    -   Users demand relevant information immediately and without interruption,
        and have increasingly high expectations regarding response time;

    -   New software applications must be developed, and existing applications
        need to be extended over the Internet; and

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    -   Organizations must deploy new applications and technologies at an
        increasingly rapid pace.

        Underlying each of these requirements is the importance of effective
management and distribution of information. While raising the strategic
importance of real-time, dynamic information, today's e-business initiatives
have heightened the challenges of developing and managing the systems to deliver
it. For example, if an electronic commerce application fails, the relationship
between the organization and the customer is jeopardized, giving new meaning to
the term "mission critical." As a result, organizations must assure that their
systems provide:

    -   Application availability -- uninterrupted and high performance access to
        applications under widely varying conditions; and

    -   Information availability -- broad distribution of critical business
        information from underlying applications to decision makers throughout
        the entire enterprise.

Application Availability

        The challenge of today's competitive environment is to provide users
with the ability to immediately execute transactions and access information,
without regard to the underlying complexities inherent in the disparate systems
that run business applications. Since the emergence of e-business has allowed
consumers to directly communicate with an organization's systems, it is more
important than ever before to maximize application performance and minimize
downtime. Furthermore, as e-business, enterprise resource planning and other
applications are deployed to a wider audience, rapid and unpredictable spikes in
the number of users can dramatically increase the likelihood of performance
degradation and system failure. Not only must organizations have adequate
back-up systems in place, but they also need solutions that will enable them to
proactively monitor, identify and resolve issues that can adversely affect
application performance. Finally, to ensure true application availability,
organizations need solutions that will enable them to quickly and accurately
develop and deploy new applications and modifications to existing applications.

Information Availability

        In addition to assuring the availability of applications, the
imperatives of e-business require organizations to make the strategic
information within these applications readily available to the users who need
it. The Internet has created a platform for distributing critical, dynamic
business information, such as inventory levels, requisitions, billing
statements, manufacturing data and sales reports to a broad range of employees,
partners and suppliers, many of whom may be located in geographically remote
locations and connected through multiple, non-integrated systems. Organizations
must be able to leverage this platform to reach customers and provide 24x7x365
access to valuable information, including customer support and current account
information. The challenge, however, is effectively extracting, publishing and
disseminating large volumes of information to thousands of employees, customers,
partners and suppliers over the Internet without massive amounts of application
reengineering.

Need for a Comprehensive Solution

        The effectiveness of an organization's information delivery system is
dependent on its application availability environment. A user's ability to
access information is linked to the performance and reliability of the
underlying application. Historically, organizations have relied on a combination
of manual processes and a heterogeneous assortment of software tools to manage
the performance and reliability of their application infrastructure and to
enable the distribution of information throughout the enterprise. However, the
requirements of today's e-business initiatives have stretched the capabilities
of these traditional solutions. This dynamic environment has created the need
for a comprehensive solution that will address the breadth of these application
and information availability requirements:

    -   Deliver data from multiple, heterogeneous sources, scale to thousands of
        users and deliver information across all environments, quickly and
        cost-effectively;

    -   Provide high performance and reliability for 24x7x365 access, and
        minimize the strain on existing systems and personnel;

    -   Be easy to use and deploy without requiring in-depth technical
        expertise;

    -   Adapt to accommodate rapidly changing business needs;

    -   Provide an architecture to realize immediate value for Web-based
        applications; and


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    -   Address these requirements across the entire Web, application and
        database environments.

THE QUEST SOLUTION

        Quest offers application and information availability software solutions
that enhance the performance and reliability of e-business, enterprise and
custom applications and enable the delivery of information across the entire
enterprise. Key elements of our solution include:

Assure Application Availability

        We offer a family of products that enhance the reliability and
performance of software applications. Our application availability products
enable the development of efficient and reliable Internet-enabled applications;
accurately deploy database and application changes; provide replication
solutions for fail-over capability, data distribution and distributing load
across multiple systems; and proactively monitor, diagnose and resolve database
and system performance issues before they are noticed by the end-user. Our
products are designed to maintain the continuous availability of applications to
the enterprise, not only in terms of uptime, but also in terms of providing
adequate performance under a wide range of operating conditions. As a result,
information technology personnel are able to efficiently and proactively enhance
the performance and reliability of critical business applications.

Extend the Reach of Information

        We enable enterprises to deliver information internally and externally
via the Internet to reach employees, customers and partners throughout large and
geographically dispersed organizations. Our Web-based information availability
solutions enable access to a greater number of users, minimize the delay in
publishing information and reduce manual printing and delivery costs associated
with paper-based report distribution. For example, these solutions can integrate
with corporate portals to allow for delivery of personalized information to a
user's desktop through a Web browser. We optimize the storage and distribution
of information by publishing information once from disparate applications to a
centralized repository. This repository serves as a common platform to capture
and distribute information without taxing the application systems or the
network. Our solution is designed to empower decision-makers by providing
relevant, dynamic information, more quickly and more cost-effectively than
previously possible.

Leverage the Web

        Our products allow organizations to leverage the functionality and
flexibility of the Internet to address the high-performance demands of
e-business environments. Specifically, our products are designed to adapt to the
varying bandwidth and response times encountered on the Internet with efficient
and fault-tolerant architectures; employ Java-based interfaces to deliver
transparent Web access to business information; and ensure the security and
integrity of Web-based access to applications.

Maximize Investment in Existing Technology

        We enable organizations to enhance the capabilities and extend the
benefits of their existing information technology infrastructure. Our products
enable existing enterprise and custom applications to reach throughout and
beyond the enterprise without requiring re-engineering. Additionally, we enable
our customers to improve the reliability and performance of existing information
technology infrastructure to cost-effectively and predictability support the
increasing number of users and large volumes of transactions required by today's
e-business applications.

Easy to Deploy and Use

        Our products are easy to deploy and use, thereby minimizing
implementation, training and support costs. We designed our products to be
installed quickly by the customer, typically without the need for on-site
assistance. Our products contain specific integration modules for SAP R/3,
PeopleSoft and Oracle Financials, enabling rapid deployment in these
environments, minimizing the need for customization and reducing ongoing
maintenance requirements.

Architected to Scale

        Our products are well-suited for large, enterprise-wide deployments. We
designed our products to effectively scale when implemented in large and rapidly
expanding environments without compromising system performance. Our products
support

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heterogeneous networks, manage large quantities of information and support
thousands of users while at the same time minimizing the consumption of network
and computing resources. Our Java user interfaces significantly reduce the need
for client-side software management, effectively leveraging today's wide
deployment of Internet browser technology.

STRATEGY

        Our objective is to become the leading provider of application and
information availability solutions to enable organizations to deliver relevant
information and provide sophisticated services to employees, customers,
suppliers and partners both inside and outside of the traditional enterprise.
Key elements of our strategy include:

Extend Product Leadership

        We offer a family of products that work together to provide application
and information availability solutions capable of meeting today's performance
requirements. We believe our family of application availability products
provides the most thorough and efficient approach to optimizing the performance
and availability of e-business, enterprise and custom applications. We also
believe that we offer the leading Web-based information availability software
solutions in terms of functionality and innovation. We intend to advance this
product leadership by investing significantly in research and development and by
acquiring and integrating complementary products and technologies. We intend to
strengthen and expand our offerings of integration software for leading
enterprise resource planning (ERP) applications. Our flexible and open
architecture allows for the integration of new modules that enhance our current
solutions and add new e-business functionality, such as electronic bill
presentment. We plan to augment our existing application availability solutions
with capabilities to monitor and maintain the underlying infrastructure of
e-business applications. For example, we plan to introduce a product that
manages and optimizes the performance of Web application servers.

Focus on e-Business Applications Market

        We believe that both recent and expected growth in e-business
applications have created strong demand for our application and information
availability products. We intend to capitalize on this opportunity by actively
marketing our products to companies with strong e-business initiatives. In
addition to developing new e-business applications, organizations are attempting
to improve the e-business functionality of their existing enterprise
applications by extending them over the Internet. As a result, we believe a
significant market opportunity exists to help organizations leverage these
investments by incorporating new e-business functionality into these systems. We
believe that our products will be used as a key component of the infrastructure
for emerging e-business applications.

Leverage our Significant Installed Base of Customers

        We have an installed base of thousands of customers that we believe
provides us with a significant opportunity for additional sales of current and
future products, as well as ongoing maintenance revenues. A majority of our
customers have purchased only one or a few of our products or use our products
in specific business-units or locations. We believe that we can sell more deeply
into our installed customer base by expanding these departmental deployments
into enterprise-wide implementations as well as by cross-selling additional
products and services.

Expand our Sales Force and Distribution Channels

        We market and sell our products worldwide primarily though a direct
sales and telesales force. We believe that our direct sales approach allows us
to achieve better control of the sales process and respond more quickly to
customer needs while maintaining an efficient sales model. We are continuing to
expand our direct sales efforts both domestically and internationally. Sales
outside of North America represented approximately 17% of total revenue in 1998
and 22% in 1999, and we believe that there is significant untapped demand for
our software products internationally. We intend to continue to expand our
direct sales staff and increase the number of sales offices internationally,
and, to a lesser extent, develop alliances with international distributors.

Extend Strategic Integrator Relationships

        We intend to increase the value of our solutions to customers by
offering additional and improved consulting and implementation services for our
enterprise-level software solutions. Specifically, we plan to extend our
existing strategic relationships and develop new partnerships with leading
global systems integrators who specialize in implementing software solutions
that support e-business and enterprise application software. We believe that
these relationships will both facilitate the successful enterprise deployment of
our products and generate additional product sales opportunities.


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SALES, MARKETING AND DISTRIBUTION

        We market and sell our products and services worldwide through a
combination of direct sales and telesales forces and, to a lesser extent,
resellers and distributors. Our domestic sales organization is headquartered in
Irvine, California. We have additional sales offices located in the metropolitan
areas of Atlanta, Boston, Chicago, Dallas, Detroit, New York, Raleigh, San
Francisco and Washington D.C. We also have international sales offices in the
metropolitan areas of Frankfurt, London and Melbourne. We are continuing to
expand our sales organization and establish additional sales offices
domestically and internationally. We also sell certain of our products through
our Web site, which allows our customers to conveniently download our products
for evaluation and direct purchase.

        Our sales and marketing approach is designed to help customers
understand both the business and technical benefits of our products.
Accordingly, we complement the efforts of our sales organization with a pre-sale
customer support organization that is responsible for addressing technical
questions related to our products. The sales team for each customer is
responsible for maintaining appropriate contacts with key information technology
personnel who have planning and purchasing responsibility within the customer's
organization. Since a number of our products affect systems and employees
throughout the enterprise, our sales effort typically involve technology
presentations and pilot implementations, and many times involve numerous
decision makers. As a result, a key feature of our sales efforts is to establish
relationships at all appropriate levels in our customers' organizations. While
the sales cycle varies substantially from customer to customer, the typical
sales cycle for our Vista Plus and SharePlex products has ranged from three to
six months.

        Focusing on our target markets, our marketing efforts are designed to
create awareness for our products and generate sales leads. To achieve these
goals, we engage in a variety of marketing activities, including seminars, trade
shows, direct mailings and print and Web-based advertising. In addition, we have
recently expanded our marketing staff and intend to commence an ongoing public
relations program that will include establishing and maintaining relationships
with key trade press, business press and industry analysts. We also intend to
initiate a customer advisory council which will provide a communication channel
for regular feedback from key customers to facilitate the design of products to
meet the expanding requirements of our target market.

CUSTOMER SERVICE AND SUPPORT

        A high level of customer service and support is critical to the
successful marketing and sale of our products and the development of long-term
customer relationships. Our customer support group provides technical support to
our customers under support agreements entered into at the time of the initial
sale. Our base level of e-mail-, Internet-, fax-, and telephone-based support
includes assistance with installation, configuration and initial set-up of our
products; ongoing support during normal business hours; and software maintenance
and upgrade releases. For an additional fee, we provide support on a 24x7x365
basis as well as training and other services.

        Customer support is provided domestically through our offices in Irvine
and internationally through our offices in Europe and Australia. We plan to hire
additional support personnel and, as needed, establish additional support sites
domestically and internationally to meet our customers' needs. Furthermore, we
plan to extend our existing strategic partnerships and develop new partnerships
with leading systems integrators to provide implementation guidance, assistance
with configuration and initial set-up of applications.

        Our services contracts are generally of 12 months' duration and are
renewable at the customer's option. Service contracts are generally priced at
approximately 20% of the amount of licenses and the customer is invoiced
annually in advance.

RESEARCH AND DEVELOPMENT

        We believe that strong research and product development capabilities are
essential to enhancing our core technologies and developing additional products
that offer maximum value and ease of use. We have invested significant time and
resources in creating a structured process for undertaking product development
projects. This process is designed to provide the proper framework for defining
and addressing the steps, tasks and activities required to bring product
concepts and development projects to market successfully. A significant portion
of our development effort is conducted in Melbourne, Australia. We have actively
recruited key software engineers and developers with expertise in the areas of
Oracle technologies, SQL Server, Java, Microsoft development technologies, ERP
systems, IBM database technologies and document management. Our engineers
include several of the industry's


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leading database management authorities. Complementing these individuals, our
senior management has extensive background in the database, network
infrastructure and enterprise and system software industries.

        Our research and development efforts focus on designing and developing
reliable, easy to install and use products that solve application and
information availability problems for our customers. Since our inception in
1987, we have made substantial investments in research and development through
both internal development and technology acquisitions. Our products utilize a
number of advanced technologies including the log analysis component of
SharePlex that allows quick and accurate determination of the database
structural and data changes with minimal overhead. Another example is our Vista
Plus product line which contains highly sophisticated postscript and PCL parsing
technology that allows these products to understand complex output data streams,
enabling search, transformation and extraction from graphics-intensive output.

COMPETITION

        The market for application and information availability solutions is
emerging rapidly, and, as a result, is intensely competitive and characterized
by rapidly changing technology and evolving standards. We expect competition to
continue to increase both from existing competitors and new market entrants. We
believe that our ability to effectively compete depends on many factors,
including:

    -   the ease of use, performance, features, price and reliability of our
        products as compared to those of our competitors;

    -   the timing and market acceptance of new products and enhancements to
        existing products developed by us and our competitors;

    -   the quality of our customer support; and

    -   the effectiveness of our sales and marketing efforts.

        Companies currently offering competitive products vary in the scope and
breadth of the products and services offered and include:

    -   providers of enterprise report management products such as Computer
        Associates, Mobius, Hewlett Packard and IBM;

    -   providers of hardware and software replication tools such as EMC and
        Veritas; and

    -   providers of database and database management products such as BMC,
        Compuware, Oracle, and Computer Associates.

        Many of our competitors and potential competitors have greater name
recognition, a larger installed customer base company-wide and significantly
greater financial, technical, marketing, and other resources than we do. Our
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements or devote greater resources to the
development, promotion and sale of their products than we can. In addition,
because there are relatively low barriers to entry in the software market, we
may encounter additional competition as other established and emerging companies
enter our field and introduce new products and technologies.

        In addition, providers of database solutions such as Oracle, Microsoft
and IBM currently produce database management tools and may in the future
enhance their products to include functionality that is currently provided by
our products. The inclusion of the functionality of our software as standard
features of the underlying database solution or application supported by our
products could render our products obsolete and unmarketable, particularly if
the quality of such functionality were comparable to that of our products. Even
if the functionality provided as standard features by these system providers is
more limited than that of our software, there can be no assurance that a
significant number of customers would not elect to accept more limited
functionality in lieu of purchasing additional software. Moreover, there is
substantial risk that the mere announcements of competing products by large
competitors such as Oracle could result in the delay or cancellation of customer
orders for our products in anticipation of the introduction of such new
products.

        In addition to the competition that we may face because of the internal
development efforts of our competitors, current and potential competitors may
make strategic acquisitions or establish cooperative relationships among
themselves or with third parties, thereby increasing their ability to address
the needs of our current or prospective customers. Accordingly, it is possible
that new competitors or alliances among current and new competitors may emerge
and rapidly gain significant market share. Such competition

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could also materially adversely affect our ability to sell our products or to
obtain maintenance and support renewals for existing licenses on terms favorable
to us.

        There can be no assurance that we will be able to compete successfully
against current and future competitors. Increased competition could result in
price reductions, fewer customer orders, reduced gross margins and loss of
market share, any of which could materially affect our business, operating
results or financial condition.

PROPRIETARY RIGHTS

        Our success and ability to compete are dependent on our ability to
develop and maintain the proprietary aspects of our technology. We rely on a
combination of trademark, trade secret, copyright law and contractual
restrictions to protect the proprietary aspects of our technology. We presently
have no patents on our products. We currently hold several trademark
registrations and have numerous trademark applications in the United States and
certain foreign countries. Our trademark applications might not result in the
issuance of any valid trademarks. We seek to protect our source code for our
software, documentation and other written materials under trade secret and
copyright laws. We license our software pursuant to signed or shrink-wrap
license agreements, which impose restrictions on the licensee's ability to
utilize the software. Finally, we seek to avoid disclosure of our intellectual
property by requiring employees and consultants with access to our proprietary
information to execute confidentiality agreements with us and by restricting
access to our source code.

        Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. In addition, we sell our products
internationally. The laws of many countries do not protect our proprietary
rights to as great an extent as do the laws of the United States. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, and to determine the validity and scope of the
proprietary rights of others. Any such resulting litigation could result in
substantial costs and diversion of resources and would materially adversely
affect our business, operating results and financial condition.

        We cannot assure you that our means of protecting our proprietary rights
will be adequate or that competition will not independently develop similar or
superior technology. We also believe that, because of the rapid rate of
technological change in the software industry, trade secret and copyright
protection are less significant than factors such as the knowledge, ability and
experience of our employees, frequent product enhancements and the timeliness
and quality of customer support services.

        Our success and ability to compete are also dependent on our ability to
operate without infringing upon the proprietary rights of others. We are not
aware that we are infringing any proprietary rights of third parties. There can
be no assurance, however, that third parties will not claim we infringe their
intellectual property rights. We expect that software product developers will
increasingly be subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time consuming to defend, result in costly litigation, divert
management's attention and resources, cause product shipment delays or require
us to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to us, if at
all. In the event of a successful claim of product infringement against us and
our failure or inability to either license the infringed or similar technology
or develop alternative technology on a timely basis, our business, operating
results and financial condition could be materially adversely affected.

        We incorporate technology from third parties into our SQL Navigator,
TOAD, Vista Plus and Foglight products. We currently have a material license
agreement with Inso for the use of file viewing technology which is incorporated
into an add-on module for our Vista Plus products. We currently pay Inso royalty
fees based on sales of our Vista Plus product. This license agreement terminates
on February 10, 2002. In addition, we currently have a material license
agreement with Artifex for the use of technology which is incorporated into an
add-on module for our Vista Plus products. We currently pay Artifex royalty fees
based on sales of Vista Plus products incorporating the licensed software. The
license for the technology from Artifex remains in effect for so long as any
proprietary rights in the licensed technology are enforceable under the laws of
any jurisdiction, unless earlier terminated by us upon 30 days written notice or
by Artifex upon a material breach by us. We also have a material license
agreement with Inxight which is incorporated into the Foglight product. We
currently pay Inxight a license fee per year plus royalty fees equal to a
percentage of the license fee. The license agreement terminates September 30,
2002. As we continue to introduce new products, we may be required to license
additional technology from others. There can be no assurance that these
third-party technology licenses will continue to be available to us on
commercially reasonable terms, if at all.

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        SharePlex is a registered trademark owned by us. This prospectus also
makes reference to the other trademarks that we own, some of which we are
seeking registration for, and to trademarks of other companies.

EMPLOYEES

        As of December 31, 1999, we employed 654 full-time employees, including
299 in sales and marketing, 226 in research and development, 52 in customer
service and support and 77 in general and administrative. We believe that our
future success will depend in large part upon our continuing ability to attract
and retain highly skilled managerial, sales, marketing, customer support and
research and development personnel. Like other software companies, we face
intense competition for such personnel, and we have at times experienced and
continue to experience difficulty in recruiting qualified personnel. There can
be no assurance that we will be successful in attracting, assimilating and
retaining other qualified personnel in the future. We are not subject to any
collective bargaining agreement and we believe that our relationships with our
employees are good.

ITEM 2. PROPERTIES

        Our principal administrative, sales, marketing, support and research and
development facility is currently located in approximately 67,500 square feet of
space in Irvine, California. This facility is under a six-year lease and we have
an option to renew this lease for an additional five-year term.

        We also lease sales offices in the metropolitan areas of Atlanta,
Boston, Calgary, Chicago, Dallas, Detroit, Israel, New York, Pleasanton,
Raleigh, San Francisco, and Washington, D.C. Our Chicago office is currently
located in approximately 30,000 square feet in Warrenville, Illinois. This
facility is under a 7-year lease. Our German subsidiary currently operates from
two facilities in Frankfurt and Dusseldorf. Our Australian subsidiary operates
from two leased facilities in Melbourne which total approximately 10,000 square
feet. Our UK subsidiary leases a 5,300 square-foot office in the London
metropolitan area.

ITEM 3. LEGAL PROCEEDINGS

        We are not currently a party to any material legal proceeding.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matters were submitted to a vote of security holders during the
fourth quarter of 1999.


                                       9
<PAGE>   12

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

        Our common stock has been listed on the Nasdaq National Market since
August 13, 1999 under the symbol "QSFT." The following table sets forth the high
and low closing sale prices on the Nasdaq National Market for our common stock
for the calendar periods indicated.

<TABLE>
<CAPTION>
                                                                   PRICE RANGE
                                                                 OF COMMON STOCK
                                                             ----------------------
                                                                HIGH         LOW
                                                             ----------   ---------
<S>                                                          <C>          <C>
YEAR ENDED DECEMBER 31, 1999:
Third Quarter (from August 13) ........................      $    52.38   $   32.56
Fourth Quarter ........................................          116.50       45.88
</TABLE>

        As of March 17, 2000, there were 153 holders of record of our common
stock.

        On March 9, 2000 the Company's Board of Directors approved a two-for-one
stock split of the Company's common stock which will be effective March 31, 2000
for shareholders of record on March 20, 2000. Share and per share information
has not been restated for this pending split. See "Selected Financial Data" and
the 1999 financial statements for proforma earnings per share information.

        RECENT SALES OF UNREGISTERED SECURITIES

During 1999, we issued unregistered securities to a limited number of persons as
described below:

    1.  In April 1999, we sold an aggregate of 2,666,667 shares of our Series A
        Preferred Stock at a price of $5.625 per share to InSight Capital
        Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., WI
        Software Investors LLC and UBS Capital LLC. Each share of Series A
        Preferred Stock was converted into one and one-half shares of common
        stock upon the completion of our initial public offering. We sold an
        aggregate of 1,777,778 shares of Series B Redeemable Preferred Stock at
        a price of $5.625 per share to UBS Capital LLC. Each share of Series B
        Redeemable Preferred Stock was redeemed upon the completion of our
        initial public offering.

    2.  Since June, 1999, we have granted stock options to purchase common stock
        under the 1999 Stock Incentive Plan to eligible officers, directors,
        consultants and employees of the Company as described in this Report.

    3.  In December 1999, we issued an aggregate of 93,471 shares of our common
        stock to the former shareholders of MBR Technologies, Inc. in connection
        with our acquisition of MBR Technologies, Inc.

        None of the foregoing transactions involved any underwriters,
underwriting discounts or commissions, or any public offering, and the
Registrant believes that each transaction was exempt from the registration
requirements of the Securities Act by virtue of Sections 3(a)(10) or 4(2)
thereof, Regulation D promulgated thereunder or Rule 701 pursuant to
compensatory benefit plans and contracts relating to compensation as provided
under such Rule 701. The recipients in such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof, and appropriate legends
were affixed to the share certificates and instruments issued in such
transactions. All recipients had adequate access, through their relationships
with the Registrant, to information about the Registrant.

USE OF INITIAL PUBLIC OFFERING PROCEEDS

        On August 18, 1999 we completed the initial public offering of our
common stock pursuant to our Registration Statement on Form S-1 (File No.
333-80543) that was declared effective by the Securities and Exchange Commission
on August 12, 1999. There has been no material change with respect to our use of
proceeds from our initial public offering to the information discussed in our
Quarterly Report on Form 10-Q for the nine months ended September 30, 1999.

DIVIDEND POLICY

        Prior to our conversion to a C corporation for tax purposes in January
1997, we paid distributions to our S corporation shareholders in amounts
generally consistent with their tax liabilities arising from their allocable
share of S corporation earnings. Since becoming a C corporation, we have not
declared or paid any cash dividends on our common stock and do not expect to do
so in the foreseeable


                                       10
<PAGE>   13
future. We currently intend to retain all available funds for use in the
operation and expansion of our business. Any future determination to pay
dividends will be at the discretion of our board of directors and will depend on
our results of operations, financial conditions, contractual and legal
restrictions and other factors the board deems relevant.



                                       11
<PAGE>   14

ITEM 6. SELECTED FINANCIAL DATA

        You should read the following selected consolidated financial data in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and the
related notes thereto appearing elsewhere in this Report. The following selected
consolidated statement of income data for the years ended December 31, 1997,
1998 and 1999, and the consolidated balance sheet data at December 31, 1998 and
1999, have been derived from audited consolidated financial statements included
elsewhere in this Report. The consolidated data presented below for the years
ended December 31, 1995 and 1996, and at December 31, 1995, 1996 and 1997, are
derived from audited consolidated financial statements that are not included in
this Report. The data presented below do not include pro forma adjustments to
reflect the income tax provision as if we were a C corporation in fiscal years
1995 and 1996.

<TABLE>
<CAPTION>
                                                                                      YEAR ENDED DECEMBER 31,
                                                                ------------------------------------------------------------------
                                                                  1995(2)       1996           1997           1998          1999
                                                                --------      --------       --------       --------      --------
                                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                             <C>           <C>            <C>            <C>           <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues:
  Licenses ...............................................      $  7,219      $  9,316       $ 12,158       $ 24,901      $ 54,269
  Services ...............................................         2,305         3,546          6,157          9,889        16,599
                                                                --------      --------       --------       --------      --------
          Total revenues .................................         9,524        12,862         18,315         34,790        70,868
                                                                --------      --------       --------       --------      --------
Cost of revenues:
  Licenses ...............................................           260           950          1,307          3,433         2,998
  Services ...............................................           980         1,467          1,972          2,507         4,195
                                                                --------      --------       --------       --------      --------
          Total cost of revenues .........................         1,240         2,417          3,279          5,940         7,193
                                                                --------      --------       --------       --------      --------
Gross profit .............................................         8,284        10,445         15,036         28,850        63,675
Operating expenses:
  Sales and marketing ....................................         2,179         4,328          5,845         11,836        32,078
  Research and development ...............................         1,134         2,995          4,293          8,047        15,980
  General and administrative .............................         2,636         3,494          3,450          5,278         9,906
  Other compensation costs and goodwill amortization .....            --            --             --             --         1,243
                                                                --------      --------       --------       --------      --------
          Total operating expenses .......................         5,949        10,817         13,588         25,161        59,207
                                                                --------      --------       --------       --------      --------
Income (loss) from operations ............................         2,335          (372)         1,448          3,689         4,468
Other income (expense), net ..............................            51           389           (137)           336         1,202
                                                                --------      --------       --------       --------      --------
Income before income tax provision .......................         2,386            17          1,311          4,025         5,670
Income tax provision .....................................            28             1          1,022          1,679         2,273
                                                                --------      --------       --------       --------      --------
Net income ...............................................      $  2,358      $     16       $    289       $  2,346         3,397
                                                                ========      ========       ========       ========      --------
Preferred stock dividends ................................                                                                     590
                                                                                                                          --------
Net income applicable to common shareholders .............                                                                $  2,807
                                                                                                                          ========
Basic and diluted net income per share ...................      $   0.12      $     --       $   0.01       $   0.05      $   0.07
Pro forma basic net income per share (1) .................      $   0.06      $     --       $     --       $   0.03      $   0.04
Pro forma  diluted net income per share (1) ..............      $   0.06      $     --       $     --       $   0.03      $   0.03
Weighted average shares outstanding:
  Basic ..................................................        19,500        38,350         40,373         44,261        37,677
  Diluted ................................................        19,500        38,350         40,617         44,459        41,800
  Pro forma basic (1) ....................................        39,000        76,700         80,746         88,522        75,354
  Pro forma diluted (1) ..................................        39,000        76,700         81,234         88,918        83,600
</TABLE>

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                ------------------------------------------------------------------
                                                                  1995          1996           1997           1998          1999
                                                                --------      --------       --------       --------      --------
                                                                                          (IN THOUSANDS)
<S>                                                             <C>           <C>            <C>            <C>           <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ................................      $  2,709      $     --       $  2,096       $  8,981      $ 39,643
Short-term marketable securities .........................            --            --             --             --        11,000
Working capital ..........................................         2,594           553            374          2,771        38,670
Total assets .............................................         6,171         6,408          9,713         19,645        99,149
Total shareholders' equity ...............................         2,996         2,429          2,836          5,074        62,669
</TABLE>

(1)  Reflects a two-for-one stock split approved on March 9, 2000 which will be
     effective March 31, 2000 for shareholders of record on March 20, 2000.

(2)  Had the Company been a C Corporation for the year ended December 31, 1995,
     the pro forma net income and net income per basic and diluted share would
     have been $1,432 and $0.07 presplit, respectively, based on the tax laws in
     effect during the period.



                                       12
<PAGE>   15

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

        The following discussion of our financial condition and results of
operations also should be read in conjunction with the consolidated financial
statements and notes to those statements included elsewhere in this Report.

OVERVIEW

        We provide application and information availability software solutions
that enhance the performance and reliability of an organization's e-business,
packaged and custom applications, and enable the delivery of information across
the entire enterprise.

        We were incorporated in 1987. At our inception, we focused on developing
and marketing software which supported developers and users of Hewlett Packard's
HP 3000 proprietary operating system known as MPE. In 1995, Vincent C. Smith
joined us as a director and in 1997, he became our chief executive officer. In
1995, we began to transition our focus from proprietary MPE technology to open
system technology. Additionally, commencing in 1995, we began extending our
Vista Plus product to open system architectures, and in 1998, we extended Vista
Plus to support the Internet. In 1996, we acquired R*Tech which developed SQLab,
our first product series for Oracle databases. In 1997, we made a number of
additional acquisitions which augmented the product line for managing Oracle
databases including our SQL Navigator, I/Watch and Schema Manager products.
Beginning in late 1997, we also began a major expansion of our research and
development, sales and marketing, and customer support organizations by adding
personnel in all departments, and through an acquisition, the establishment of
operations in Australia and the United Kingdom. Commencing in the second half of
1998, we also introduced several additional products including SharePlex and
SQLab Xpert. In 1998, we also established a direct sales operation in Germany.
In 1999, we introduced Instance Monitor and Data Manager.

        In December 1999, we acquired MBR Technologies, Inc. and its Stat!
product for consideration consisting of 93,471 shares of our common stock valued
at $9.3 million and a cash payment of $1.3 million, and the assumption of net
liabilities of $340,000. Of the total purchase price, which included direct
acquisition costs, $11.5 million was allocated to goodwill, which will be
amortized over a five-year period, and $784,000 was allocated to assumed
liabilities.

        In January 2000, we acquired Foglight Software, Inc. and its Foglight
product for consideration consisting of 1,187,603 shares of our common stock
valued at $104.2 million, a cash payment of $0.4 million, the assumption of
unvested Foglight stock options valued at $2.2 million and the assumption of net
liabilities of $4.1 million. The total purchase price, which included direct
acquisition costs, is estimated to be allocated primarily to goodwill and other
intangible assets, which will be amortized primarily over a five-year period.

        In February 2000, we acquired QMaster Software Solutions, Inc. and the
QMaster Output product for $15 million in cash. The total purchase price, which
will include direct costs of the acquisition estimated to be $75,000, is
estimated to be allocated primarily to goodwill, which will be amortized over a
five-year period.

        We derive our revenues primarily from the sale of software licenses and
related annual maintenance fees. Our total revenues have increased over each of
the past five fiscal years, from $9.5 million in 1995 to $70.9 million in 1999.
Pricing of our software licenses is based on the number of servers, workstations
and/or users of our products. Annual maintenance contracts may be purchased
separately by customers at their discretion.

        We recognize software license revenues when a non-cancellable license
agreement has been signed with a customer, the software is shipped, no
significant post-delivery vendor obligations remain and collection is deemed
probable. Maintenance revenues are recognized ratably over the contract term,
which is typically one year. Revenues for consulting services are recognized as
such services are performed. See Note 1 of the notes to our consolidated
financial statements.

        We market our software and services primarily through our direct sales
organization in the United States, Australia, the United Kingdom and Germany.
International revenues from licenses and services sold to customers outside of
North America were $1.4 million in 1997, $5.8 million in 1998, and $15.3 million
in 1999. We intend to expand our international sales activities as part of our
business strategy. All of our current international revenues are derived from
the operations of our three wholly owned subsidiaries in Australia, the United
Kingdom and Germany. Our international subsidiaries conduct business in the
currency of the country in which they operate, exposing us to currency
fluctuations and currency transaction losses or gains which are outside of our
control. Historically, fluctuations in foreign currency exchange rates have not
had a material effect on our business. We have not, to date, conducted any
hedging transactions to reduce our risk to currency fluctuations.


                                       13
<PAGE>   16
        In the development of new products and enhancements of existing
products, the technological feasibility of the software is not established until
substantially all product development is complete. Historically, our software
development costs eligible for capitalization have been insignificant, and all
costs related to internal research and development have been expensed as
incurred.

        At the time of our incorporation, we elected to be treated as an S
corporation under Subchapter S of the Internal Revenue Code. As an S
corporation, our shareholders were liable for federal income tax liabilities
resulting from our operations. Effective January 1, 1997, we terminated our
status as an S corporation and for all periods thereafter, we have been liable
for federal income taxes. Prior to the termination of our S corporation status,
we declared distributions as dividends to shareholders payable in cash in an
amount generally equal to the tax consequence created by our earnings up to the
date of such termination.

RESULTS OF OPERATIONS

        The following table sets forth certain consolidated statement of income
data as a percentage of total revenues for the periods indicated:

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                                  ------------------------------
                                                  1997         1998        1999
                                                  -----        -----       -----
<S>                                               <C>          <C>         <C>
Revenues:
  Licenses .................................       66.4%        71.6%       76.6%
  Services .................................       33.6         28.4        23.4
                                                  -----        -----       -----
          Total revenues ...................      100.0        100.0       100.0
                                                  -----        -----       -----
Cost of revenues:
  Licenses .................................        7.1          9.9         4.2
  Services .................................       10.8          7.2         5.9
                                                  -----        -----       -----
          Total cost of revenues ...........       17.9         17.1        10.1
                                                  -----        -----       -----
Gross profit ...............................       82.1         82.9        89.9

Operating expenses:
  Sales and marketing ......................       31.9         34.0        45.3
  Research and development .................       23.5         23.1        22.6
  General and administrative ...............       18.8         15.2        14.0
  Other compensation costs and goodwill
    amortization ...........................         --           --         1.8
                                                  -----        -----       -----
          Total operating expenses .........       74.2         72.3        83.7
                                                  -----        -----       -----
Income from operations .....................        7.9         10.6         6.2
Other  income (expense), net ...............       (0.7)         0.9         1.7
                                                  -----        -----       -----
Income before income tax provision .........        7.2         11.5         7.9
Income tax provision .......................        5.6          4.8         3.2
                                                  -----        -----       -----
Net income .................................        1.6%         6.7%        4.7%
                                                  =====        =====       =====
</TABLE>

YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999

REVENUES

        Revenues were $18.3 million, $34.8 million and $70.9 million for 1997,
1998 and 1999, respectively, representing increases of $16.5 million, or 90.2%,
from 1997 to 1998, and $36.1 million, or 103.7%, from 1998 to 1999.
International revenues accounted for 7.4%, 16.7% and 21.6% of total revenues for
1997, 1998 and 1999, respectively. No customer accounted for more than 10.0% of
total revenues in 1997, 1998 or 1999.

        Licenses -- Licenses were $12.2 million, $24.9 million and $54.3 million
in 1997, 1998 and 1999, respectively, representing increases of $12.7 million,
or 104.1%, from 1997 to 1998, and $29.4 million, or 118.1%, from 1998 to 1999.
Licenses represented 66.4%, 71.6% and 76.6% of total revenues in 1997, 1998 and
1999, respectively. International licenses accounted for 8.2%, 18.6% and 23.4%
of total licenses in 1997, 1998 and 1999, respectively. The increase in licenses
from 1997 to 1998 was due to the expansion of our domestic sales organization of
67 people, a $3.6 million increase in international license revenue, greater
market acceptance of our products for the Oracle database market and the success
of our Vista Plus product for the UNIX environment. The increase in licenses
from 1998 to 1999 was due to both an increase in our worldwide sales force of
176 people, as well as the availability of new products for all of 1999
including Schema Manager, I/Watch and TOAD.

        Services -- Services were $6.2 million, $9.9 million and $16.6 million
in 1997, 1998 and 1999, respectively, representing increases of $3.7 million, or
60.6%, from 1997 to 1998, and $6.7 million, or 67.7%, from 1998 to 1999.
Services represented 33.6%, 28.4% and 23.4% of total revenues in 1997, 1998 and
1999, respectively. The increases in services reflect an increase in the number
of software licenses sold with maintenance agreements. International services
accounted for 5.7%, 11.9% and 15.9% of total services in 1997, 1998 and 1999,
respectively.

                                       14
<PAGE>   17
COST OF REVENUES

        Cost of Licenses -- Cost of licenses was $1.3 million, $3.4 million and
$3.0 million in 1997, 1998 and 1999, respectively, representing an increase of
$2.1 million, or 161.5%, from 1997 to 1998, and a decrease of $.4 million, or
11.8%, from 1998 to 1999. Cost of licenses as a percentage of license revenue
was 10.8%, 13.8% and 5.5% for 1997, 1998 and 1999, respectively. The increase in
cost of licenses as a percentage of license revenue from 1997 to 1998 was
attributable primarily to a $1.8 million increase in royalties and a $551,000
increase in amortization of purchased technology and software licenses. The
decrease in cost of licenses from 1998 to 1999 was due to decreases for both
royalties and amortization as a result of reaching several royalty maximums and
completion of amortization of certain purchased technology.

        Cost of Services -- Cost of services was $2.0 million, $2.5 million and
$4.2 million in 1997, 1998 and 1999, respectively, representing increases of
$500,000, or 25.0%, from 1997 to 1998 and $1.7 million, or 68.0%, from 1998 and
1999. The increases over these periods were primarily due to an increase in the
number of customer support personnel to service our growing customer and product
base. Cost of services as a percentage of service revenues was 32.0%, 25.4% and
25.3% for 1997, 1998 and 1999, respectively. The decreases in cost of services
as a percentage of services over these periods were primarily due to economies
of scale realized as a result of our increasing service revenues.

OPERATING EXPENSES

        Sales and Marketing -- Sales and marketing expenses were $5.8 million,
$11.8 million and $32.1 million in 1997, 1998 and 1999, respectively,
representing increases of $6.0 million, or 103.4%, from 1997 to 1998, and $20.3
million, or 172.0%, from 1998 to 1999. The increases reflect our increasing
investment in our sales and marketing organization, which from 1997 to 1998
included a $3.6 million increase in salaries and related expenses, a $1.1
million increase in additional commissions, and a $353,000 increase in marketing
communications expenses such as trade shows and advertising. The increases from
1998 to 1999 reflect an increase in salaries and related expenses of $8.9
million, a $4.3 million increase in commissions and a $627,000 increase in
marketing communications expenses. Travel and entertainment expenses, and
related costs of hiring sales and marketing management, also increased for both
periods.

        Research and Development -- Research and development expenses were $4.3
million, $8.0 million and $16.0 million in 1997, 1998 and 1999, respectively,
representing increases of $3.7 million, or 86.0%, from 1997 to 1998, and $8.0
million, or 100.0%, from 1998 to 1999. The increases for these periods were
primarily related to a 63 person increase from 1997 to 1998, and a 138 person
increase from 1998 to 1999, in the number of software developers and quality
assurance personnel and, to a lesser extent, an increase in the cost of hiring
outside contractors to support product development activities.

        General and Administrative -- General and administrative expenses were
$3.5 million, $5.3 million and $9.9 million in 1997, 1998 and 1999,
respectively, representing an increase of $1.8 million, or 51.4%, from 1997 to
1998, and an increase of $4.6 million or 86.8% from 1998 to 1999. The most
significant expense increases during both periods were for salaries and related
expenses and rent.

        Other Compensation Costs and Goodwill Amortization -- Compensation costs
and goodwill amortization were $1.2 million in 1999 and includes $715,000
related to the severance package provided to Doran Machin, one of our founders
and a director, which will be paid out over a three-year period, $432,000 of
compensation costs related to the grant of stock options at less than fair
market value and $97,000 of goodwill amortization related to acquisitions.

        Other Income (Expense), Net -- Other income (expense), net was
$(137,000) in 1997, $336,000 in 1998, and $1.2 million in 1999, representing an
increase of $473,000 from 1997 to 1998, and an increase of $864,000 from 1998 to
1999. The increases reflect increased interest income from higher cash and
short-term investments which accelerated in 1999 after the receipt of the net
proceeds of our initial public offering.

        Provision for Income Taxes -- Provision for income taxes was $1.0
million, $1.7 million and $2.3 million in 1997, 1998 and 1999, respectively,
representing increases of $700,000, or 70.0%, from 1997 to 1998, and an increase
of $600,000, or 35.3%, from 1998 to 1999. The effective income tax rate was
78.0%, 41.7% and 40.1% in 1997, 1998 and 1999, respectively. The high effective
tax rate in 1997 is attributable to our election, effective January 1, 1997, to
terminate our status as an S corporation under federal tax regulations which
resulted in the establishment of deferred taxes. See Note 6 of the notes to our
consolidated financial statements.

                                       15
<PAGE>   18
INFLATION

        Inflation has not had a significant effect on our results of operations
or financial position for the years ended December 31, 1997, 1998 and 1999.

LIQUIDITY AND CAPITAL RESOURCES

        We have funded our business, to date, primarily from cash generated by
our operations and net proceeds of $64.9 million from our initial public
offering in August 1999. Our sources of liquidity as of December 31, 1999
consisted principally of cash and cash equivalents of $39.6 million and
marketable securities of $15.5 million.

        Net cash provided by operating activities was $3.6 million, $8.2 million
and $11.4 million in 1997, 1998 and 1999, respectively. The increases in 1997,
1998 and 1999, were primarily due to increases in net income, depreciation and
amortization, deferred revenue resulting from additional service contracts and
accrued expenses, offset by increases in accounts receivable resulting from
increased sales.

        Net cash used in investing activities was $1.3 million, $1.3 million,
and $24.1 million in 1997, 1998, and 1999, respectively. The increase in cash
used in investing activities in 1999 was primarily related to capital
expenditures of $7.1 million associated with company growth and net purchases of
marketable securities totalling $15.5 million.

        Financing activities used $270,000 and $8,000 in 1997 and 1998,
respectively, and generated $43.6 million in 1999. In April 1999, we raised
$25.0 million through the sale of preferred stock and an additional $10.0
million in term debt from a commercial bank in order to purchase shares of
common stock from a shareholder and founder for $35.0 million. See Note 4 of the
notes to our consolidated financial statements. In August 1999, we raised net
proceeds of $64.9 million from our initial public offering. A portion of the
proceeds was utilized to retire debt of $10.9 million and redeem the outstanding
Series B Preferred Stock for $10.0 million. In March 2000, we raised net
proceeds of $253.6 million from a secondary public offering of 4.2 million
shares of our common stock at a price of $140.00 per share. Of the shares sold
in the offering 1,904,230 shares were sold by the Company and 2,295,770 shares
were sold by existing shareholders.

        We plan to use the proceeds of the offering for general corporate
purposes, including working capital, expanding sales and marketing efforts,
product development, expansion of our customer support organization, possible
acquisitions and capital expenditures. We did not receive any proceeds from the
shares sold by the selling shareholders. We believe that the net proceeds from
the offering, our existing cash and investment balances and cash from operations
will be sufficient to finance our operations through at least the next 12
months. If additional financing is needed, we can not assure you that such
financing will be available to us on commercially reasonable terms or at all.


                                       16
<PAGE>   19

                                  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."

    -   increased expenses, whether related to sales and marketing, product
        development or administration;

    -   our ability to attain market acceptance of new products and services and
        enhancements to our existing products;

    -   delays in introducing new products;

    -   new product introductions by competitors;

    -   lack of order backlog;

    -   changes in our pricing policies or the pricing policies of our
        competitors;

    -   costs related to acquisitions of technologies or businesses;

    -   the timing of releases of new versions of third-party software products
        that our products support, including, without limitation, product
        releases by Oracle; and

    -   the amount and timing of expenditures related to expansion of our
        operations.

THE SIZE AND TIMING OF OUR CUSTOMER ORDERS MAY VARY SIGNIFICANTLY FROM QUARTER
TO QUARTER WHICH COULD CAUSE FLUCTUATIONS IN OUR REVENUES

        In any given quarter, sales of some of our products have involved large
financial commitments from a relatively small number of customers, and
cancellation or deferral of these large contracts would reduce our revenues. In
addition, the sales cycles for Vista Plus and SharePlex have been up to six
months and often require pre-purchase evaluation periods and customer education.
These relatively long sales cycles may cause significant periodic variation in
our license revenues. Also, we have often booked a large amount of our sales in
the last month or weeks of each quarter and delays in the closing of sales near
the end of a quarter could cause quarterly revenue to fall short of anticipated
levels. Finally, while a portion of our revenues each quarter is recognized from
previously deferred revenue, our quarterly performance will depend primarily
upon entering into new contracts to generate revenues for that quarter.

MANY OF OUR PRODUCTS ARE DEPENDENT ON ORACLE'S TECHNOLOGIES AND IF ORACLE'S
TECHNOLOGIES LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS, THE
DEMAND FOR OUR PRODUCTS COULD SUFFER

        We believe that our success has depended in part, and will continue to
depend in part for the foreseeable future, upon our relationship with Oracle and
our status as a complementary software provider for Oracle's database and
application products. Many


                                       17
<PAGE>   20

versions of our principal products, including SharePlex, SQLab Xpert, and SQL
Navigator, are designed specifically to be used with Oracle databases. Although
a number of our products work with other environments, our competitive advantage
consists in substantial part on the integration between our products and
Oracle's products, and our extensive knowledge of Oracle's technology.
Currently, a significant portion of our total revenues are derived from products
that specifically support Oracle-based products. If Oracle for any reason
decides to promote technologies and standards that are not compatible with our
technology, or if Oracle loses market share for its database products, our
business, operating results and financial condition would be materially
adversely affected.

MANY OF OUR PRODUCTS ARE VULNERABLE TO DIRECT COMPETITION FROM ORACLE

        We currently compete with Oracle in the market for database management
solutions. We expect that Oracle's commitment to and presence in the database
management product market will increase in the future and therefore
substantially increase competitive pressures. We believe that Oracle will
continue to incorporate database management technology into its server software
offerings, possibly at no additional cost to its users. We believe that Oracle
will also continue to enhance its database management technology. Furthermore,
Oracle could attempt to increase its presence in this market by acquiring or
forming strategic alliances with our competitors, and Oracle may be in better
position to withstand and respond to the current factors impacting this
industry. Oracle has a longer operating history, a larger installed base of
customers and substantially greater financial, distribution, marketing and
technical resources than we do. In addition, Oracle has well-established
relationships with many of our present and potential customers. As a result, we
may not be able to compete effectively with Oracle in the future which could
materially adversely affect our business, operating results and financial
condition. See "Business -- Competition."

ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR
BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION

        We have in the past made and we expect to continue to make acquisitions
of complementary companies, products or technologies. In this regard, we
recently acquired MBR Technologies, Inc., Foglight Software, Inc., and QMaster
Software Solutions, Inc. If we make any additional acquisitions, we will be
required to assimilate the operations, products and personnel of the acquired
businesses and train, retain and motivate key personnel from the acquired
businesses. We may be unable to maintain uniform standards, controls, procedures
and policies if we fail in these efforts. Similarly, acquisitions may subject us
to liabilities and risks that are not known or identifiable at the time of the
acquisition or may cause disruptions in our operations and divert management's
attention from day-to-day operations, which could impair our relationships with
our current employees, customers and strategic partners. We may have to incur
debt or issue equity securities to pay for any future acquisitions. The issuance
of equity securities for any acquisition could be substantially dilutive to our
shareholders. In addition, our profitability may suffer because of
acquisition-related costs or amortization costs for acquired goodwill and other
intangible assets. In consummating acquisitions, we are also subject to risks of
entering geographic and business markets in which we have no or limited prior
experience. If we are unable to fully integrate acquired businesses, products or
technologies with our existing operations, we may not receive the intended
benefits of acquisition.

OUR ABILITY TO INCREASE OUR REVENUES DEPENDS ON OUR ABILITY TO EXPAND OUR
INDIRECT SALES CHANNELS

        Our ability to increase revenues in the future substantially depends on
our ability to expand our indirect sales channel.

        In certain domestic and international markets we may miss sales
opportunities if we are unable to enter into successful relationships with
locally based resellers. In the future, we intend to augment our current limited
indirect sales distribution methods through additional third-party distribution
arrangements and, therefore, we will likely become more dependent on these type
of relationships. There can be no assurance that we will successfully augment
these arrangements or that the expansion of indirect sales distribution methods
will increase revenues.

OUR PAST AND FUTURE GROWTH MAY STRAIN OUR MANAGEMENT, ADMINISTRATIVE,
OPERATIONAL AND FINANCIAL INFRASTRUCTURE

        We have recently experienced a period of rapid growth in our operations
that has placed and will continue to place a strain on our management,
administrative, operational and financial infrastructure. During this period, we
have experienced an increase in the number of our employees, increasing demands
on our operating and financial systems and personnel, and an expansion in the
geographic coverage of our operations. The number of our full-time employees
increased from 66 as of December 31, 1996 to 123 as of December 31, 1997, to 257
as of December 31, 1998, and to 654 as of December 31, 1999. Our ability to
manage our operations and growth requires us to continue to improve our
operational, financial and management controls, and reporting systems and
procedures. In addition, we will be required to hire additional management,
financial, and sales and marketing personnel to manage our expanding operations.
If we are unable to manage this growth effectively, our business, operating
results and financial condition may be materially adversely affected.


                                       18
<PAGE>   21

WE MAY NOT GENERATE INCREASED BUSINESS FROM OUR CURRENT CUSTOMERS WHICH COULD
SLOW OUR REVENUE GROWTH IN THE FUTURE

        Most of our customers initially make a purchase of our products for a
single department or location. Many of these customers may choose not to expand
their use of our products. If we fail to generate expanded business from our
current customers, our business, operating results and financial condition could
be materially adversely affected. In addition, as we deploy new modules and
features for our existing products or introduce new products, our current
customers may choose not to purchase this new functionality or these new
products. Moreover, if customers elect not to renew their maintenance
agreements, our service revenues would be materially adversely affected.

BECAUSE THE MARKET FOR E-BUSINESS SOLUTIONS IS NEW AND EVOLVING, WE CANNOT
ACCURATELY PREDICT THE FUTURE GROWTH RATE OF THIS MARKET OR ITS ULTIMATE SIZE

        We are increasingly focusing our selling efforts on providing
application and information availability solutions for e-business applications
and we expect such sales to constitute an increasing portion of our future
revenue growth. We believe that most companies currently are not yet aware of
our products and capabilities within this evolving market, and, as a result,
such companies have not deployed our solutions. While we have devoted
significant resources to promoting awareness of our products and the problems
these products address for this evolving market, these efforts may not be
sufficient to build market awareness of the need for our products. Failure of a
significant market for e-business application and information availability
products to develop, or failure of our products to achieve broad market
acceptance, could have a material adverse effect on our business, operating
results and financial condition.

WE EXPECT TO INCUR SIGNIFICANT INCREASES IN OUR OPERATING EXPENSES IN THE
FORESEEABLE FUTURE, WHICH MAY AFFECT OUR FUTURE PROFITABILITY

        We intend to substantially increase our operating expenses for the
foreseeable future as we:

    -   increase our sales and marketing activities, including expanding our
        direct sales and telesales forces;

    -   increase our research and development activities;

    -   expand our general and administrative activities; and

    -   expand our customer support organizations.

Accordingly, we will be required to significantly increase our revenues in order
to maintain profitability. These expenses will be incurred before we generate
any revenues by this increased spending. If we do not significantly increase
revenues from these efforts, our business and operating results would be
negatively impacted.

OUR INTERNATIONAL OPERATIONS AND OUR PLANNED EXPANSION OF OUR INTERNATIONAL
OPERATIONS EXPOSES US TO CERTAIN RISKS

        Substantially all of our current international revenues are derived from
the operations of our three wholly-owned subsidiaries in Australia, the United
Kingdom and Germany. Revenues from licenses and services to customers outside of
North America were $5.8 million in 1998, representing 16.7% of total revenues,
and $15.3 million in the year ended December 31, 1999, representing 21.6% of
total revenues. As a result, we face increasing risks from doing business on an
international basis, including, among others:

    -   difficulties in staffing and managing foreign operations;

    -   longer payment cycles;

    -   seasonal reductions in business activity in Europe;

    -   increased financial accounting and reporting burdens and complexities;

    -   potentially adverse tax consequences;


                                       19
<PAGE>   22

    -   delays in localizing our products;

    -   compliance with a wide variety of complex foreign laws and treaties;

    -   reduced protection for intellectual property rights in some countries;
        and

    -   licenses, tariffs and other trade barriers.

In addition, because our international subsidiaries conduct business in the
currency of the country in which they operate, we are subject to currency
fluctuations and currency transaction losses or gains which are outside of our
control.

        We plan to expand our international operations as part of our business
strategy. The expansion of our existing international operations and entry into
additional international markets will require significant management attention
and financial resources and will place additional burdens on our management,
administrative, operational and financial infrastructure. We cannot be certain
that our investments in establishing facilities in other countries will produce
desired levels of revenue or profitability. In addition, we have sold our
products internationally for only a few years and we have limited experience in
developing localized versions of our products and marketing and distributing
them internationally. As our international operations expand, our exposure to
exchange rate fluctuations will increase as we use an increasing number of
foreign currencies. We have not yet entered into any hedging transactions to
date to mitigate our expense to currency fluctuations.

FAILURE TO DEVELOP STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS BY DENYING US
SELLING OPPORTUNITIES AND OTHER BENEFITS

        Our current collaborative relationships may not prove to be beneficial
to us, and they may not be sustained. We also may not be able to enter into
successful new strategic relationships in the future, which could have a
material adverse effect on our business, operating results and financial
condition. From time to time, we have collaborated with other companies,
including Hewlett-Packard and Oracle and certain regional offices of a number of
the national accounting firms that provide system integration services, in areas
such as product development, marketing, distribution and implementation. We
could lose sales opportunities if we fail to work effectively with these
parties. Moreover, we expect that maintaining and enhancing these and other
relationships will become a more meaningful part of our business strategy in the
future. However, many of our current partners are either actual or potential
competitors with us. In addition, many of these third parties also work with
competing software companies and we may not be 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.


                                       20
<PAGE>   23

OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS ERRORS

        The software products we offer are inherently complex. Despite testing
and quality control, we cannot be certain that errors will not be found in
current versions, new versions or enhancements of our products after
commencement of commercial shipments. Significant technical challenges also
arise with our products because our customers purchase and deploy our products
across a variety of computer platforms and integrate it with a number of
third-party software applications and databases. If new or existing customers
have difficulty deploying our products or require significant amounts of
customer support, our operating margins could be harmed. Moreover, we could face
possible claims and higher development costs if our software contains undetected
errors or if we fail to meet our customers' expectations. As a result of the
foregoing, we could experience:

    -   loss of or delay in revenues and loss of market share;

    -   loss of customers;

    -   damage to our reputation;

    -   failure to achieve market acceptance;

    -   diversion of development resources;

    -   increased service and warranty costs;

    -   legal actions by customers against us which could, whether or not
        successful, increase costs and distract our management; and

    -   increased insurance costs.

        In addition, a product liability claim, whether or not successful, could
harm our business by increasing our costs and distracting our management.

WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR PRODUCTS
AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY
SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE DEMAND FOR, OR
PREVENT THE SHIPPING OF, OUR PRODUCTS

        Our SQL Navigator, TOAD, Vista Plus and Foglight products contain
components developed and maintained by third-party software vendors. For
example, we incorporate software licensed from Inso Corporation and Artifex
Software into add-on options for our Vista Plus products. Similarly, our
Foglight product incorporates software licensed from Inxight. We expect that we
may have to incorporate software from third-party vendors in our future
products. We may not be able to replace the functionality provided by the
third-party software currently offered with our products if that software
becomes obsolete, defective or incompatible with future versions of our products
or is not adequately maintained or updated. Any significant interruption in the
availability of these third-party software products or defects in these products
could harm our sales unless and until we can secure an alternative source.
Although we believe there are adequate alternate sources for the technology
licensed to us by Inso, Artifex and Inxight, such alternate sources may not
provide us with the same functionality as that currently provided to us.
Further, we may experience a delay in obtaining an alternate source for the file
viewing technology licensed to us by Inso if our license with Inso becomes
unavailable for any reason.

                          RISKS RELATED TO OUR INDUSTRY

YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS AND COULD CAUSE DISRUPTION TO OUR
BUSINESS

        Although we have not experienced any Year 2000 problems, it is possible
that, even after January 1, 2000, Year 2000-related issues may cause problems or
disruptions. While we believe that all of our systems are Year 2000 compliant,
we cannot assure you that we will not discover a problem during 2000 that needs
to be upgraded, modified or replaced. In addition, we depend on a number of
third-party vendors to provide both information and non-information technology
systems and services. While we believe that our material third-party systems and
services are Year 2000 compliant, we cannot be sure that we will not experience
any problems during 2000. We also cannot provide any assurance that governmental
agencies, utility companies, Internet access companies and others outside of our
control will not experience any future Year 2000 problems.


                                       21
<PAGE>   24

THE DEMAND FOR OUR PRODUCTS WILL DEPEND ON OUR ABILITY TO ADAPT TO RAPID
TECHNOLOGICAL CHANGE

        Our future success will depend on our ability to continue to enhance our
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments and satisfy increasingly
sophisticated customer requirements. Rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer demands and evolving industry standards characterize the market for
our products. The introduction of products embodying new technologies and the
emergence of new industry standards can render our existing products obsolete
and unmarketable. As a result of the complexities inherent in today's computing
environments and the performance demanded by customers for embedded databases
and Web-based products, new products and product enhancements can require long
development and testing periods. As a result, significant delays in the general
availability of such new releases or significant problems in the installation or
implementation of such new releases could have a material adverse effect on our
business, operating results and financial condition. We may not be successful
in:

    -   developing and marketing, on a timely and cost-effective basis, new
        products or new product enhancements that respond to technological
        change, evolving industry standards or customer requirements;

    -   avoiding difficulties that could delay or prevent the successful
        development, introduction or marketing of these products; or

    -   achieving market acceptance for our new products and product
        enhancements.

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.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

        In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard , or SFAS, No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes methods for
derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. Because we do not currently
hold any derivative instruments and do not currently engage in hedging
activities, we expect that the adoption of SFAS No. 133 will not have a material
impact on our financial position or results of operations. We will be required
to implement SFAS No. 133 for the year ending December 31, 2001.

        In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2,
Software Revenue Recognition, with respect to Certain Transactions. SOP 98-9
amends SOP 97-2 and SOP 98-4, extending the deferral of the application of
certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal years
beginning on or before March 15, 1999. All other provisions of SOP 98-9 are
effective for transactions entered into in fiscal years beginning after March
15, 1999. We do not expect the adoption of SOP 98-9 to have a material effect on
our financial position or results of operations.


                                       22
<PAGE>   25

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN CURRENCY HEDGING INSTRUMENTS

        We transact business in various foreign currencies. Accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
This exposure is primarily related to revenues and operating expenses in
Australia, the United Kingdom and Germany denominated in the respective local
currency.

        To date, we have not used hedging contracts to hedge our
foreign-currency fluctuation risks. We will assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis. We also do not use
derivative financial instruments for speculative trading purposes.

INTEREST RATE RISK

        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. At December 31, 1999 approximately half of our investment portfolio was
invested in tax-free securities. Beginning in January 2000, we began to
transition our investment portfolio from tax-free to taxable securities.
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 December 31, 1999, the net loss on
available-for-sale securities of $26,000 comprises five positions, all with
unrealized losses.

        The following table provides information about our investment
portfolio at December 31, 1999. For investment securities, the table presents
principal cash flows and related weighted average interest rates by expected
maturity dates.

                                                           DECEMBER 31,
                                                              1999
                                                           ------------
Cash and cash equivalents                                     39,643
Average interest rate                                           4.51%

Short-term marketable securities, available-for-sale          11,000
Average interest rate                                           4.50%

Long-term marketable securities, available-for-sale
(maturing in 2001)                                             4,484
Average interest rate                                           3.94%

Total portfolio                                               55,127
Average interest rate                                           4.46%

        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. Accordingly,
changes in the market interest rate would not have a material effect on the fair
value of such investments.

EUROPEAN MONETARY UNION

        Within Europe, the European Economic and Monetary Union introduced a new
currency, the euro, on January 1, 1999. The new currency is in response to the
European Union's policy of economic convergence to harmonize trade policy,
eliminate business costs associated with currency exchange, and to promote the
free flow of capital, goods and services.

        On January 1, 1999, the participating countries adopted the euro as
their local currency, initially available for currency trading on currency
exchanges and non-cash transactions such as banking. The existing local
currencies, or legacy currencies, will remain legal tender through January 1,
2002. Beginning on January 1, 2002, euro-denominated bills and coins will be
issued for cash transactions. For a period of up to six months from this date,
both legacy currencies and the euro will be legal tender. On or before July 1,
2002, the participating countries will withdraw all legacy currencies and
exclusively use the euro.

        Our transactions are recorded in both U.S. dollars and foreign
currencies. Future transactions may be recorded in the euro. We have not
incurred and do not expect to incur any significant costs from the continued
implementation of the euro. However, the currency risk of the euro could harm
our business.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The financial statements and supplementary data required by this item
are included in Part IV, Item 14 of this Form 10-K and are presented beginning
on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

        Not applicable.




                                       23

<PAGE>   26
\
                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        Information regarding the Company's directors as required by this item
will be included in the Company's proxy statement, to be delivered to
shareholders in connection with the Company's annual meeting of shareholders to
be held on May 16, 2000. Such information is incorporated herein by reference.

        The following table sets forth certain information regarding our
executive officers and directors as of February 1, 2000:

<TABLE>
<CAPTION>
      NAME                                     AGE                       POSITION
      ----                                     ---                       --------
<S>                                            <C>  <C>
      Vincent C. Smith.......................  36   Chief Executive Officer and Chairman of the Board
      David M. Doyle(2)......................  39   President, Secretary and Director
      John J. Laskey.........................  50   Chief Financial Officer and Vice President, Finance
      Eyal M. Aronoff........................  36   Vice President, Technology and Engineering
      Douglas F. Garn........................  41   Vice President, Worldwide Sales
      Doran G. Machin(1)(2)..................  45   Director
      Jerry Murdock, Jr.(1)(2)...............  41   Director
</TABLE>

--------------------
(1)  Member of Compensation Committee

(2)  Member of Audit Committee

        Set forth below is certain information regarding the business experience
during the past five years of each of the above-named persons.

        Vincent C. Smith has served as our Chief Executive Officer since 1997
and a director since 1995. Mr. Smith became Chairman of the Board in 1998. In
1994, Mr. Smith was Director of Open Systems at BMC Software, where he managed
its sales operations. From 1992 to 1994, Mr. Smith co-founded Patrol Software
North America and served as its Vice President of Worldwide Sales and Marketing.
Patrol Software merged with BMC in 1994. Mr. Smith worked at Oracle Corporation
from 1987 to 1992 in a variety of sales management positions. Mr. Smith received
his B.S. degree in Computer Science with a minor in Economics from University of
Delaware.

        David M. Doyle is our President, Secretary, founder and a director. Mr.
Doyle has been President and a director since the formation of Quest in 1987 and
has been our Secretary since June 1999. Mr. Doyle was the primary designer and
developer of our products during the initial four years after the founding of
Quest. Prior to the founding of Quest, Mr. Doyle served as a consultant to a
variety of industries, specializing in the areas of system design and
application performance and co-founded American Data Industries. Mr. Doyle
studied Information and Computer Sciences at University of California, Irvine.

        John J. Laskey is our Chief Financial Officer and Vice President,
Finance. Mr. Laskey has held these positions since October 1998. From June 1995
to October 1998, Mr. Laskey served as the Chief Financial Officer and Vice
President, Finance of Continuus Software Corporation, a provider of software
change management solutions. From April to June 1995, Mr. Laskey was the Chief
Financial Officer and Vice President, Finance of StarBase Corporation. From
September 1986 to April 1995, Mr. Laskey worked at FileNet Corporation as Vice
President, Finance and Principal Accounting Officer. Mr. Laskey received his
B.S. degree in Electrical Engineering from University of Illinois and his M.B.A.
from Loyola University of Chicago.

        Eyal M. Aronoff has been our Vice President of Technology and
Engineering since March 1996, when we acquired R*Tech Systems, Inc., a database
management company. Mr. Aronoff founded R*Tech Systems in 1992 and served as its
President from 1992 to 1996. Prior to this, Mr. Aronoff worked for John Bryce
Ltd., an Oracle distributor in Israel, attended school and served in the Israeli
Defense Force. Mr. Aronoff received a B.A. degree in computer science and
chemistry from Bar-Ilan University Ramat-Gan, Israel.

        Douglas F. Garn is the Vice President of Worldwide Sales. Mr. Garn has
held this position since January 1998. From March 1996 to January 1998, Mr. Garn
was Vice President of North American Sales for Peregrine Systems, Inc. From July
1995 until April 1996, Mr. Garn was Vice President of Sales with Syntax, Inc., a
networking software company. From November 1993 until July 1995, Mr. Garn was
Regional Sales Manager with BMC. Mr. Garn holds a B.S. in Marketing from
University of Southern California.



                                       24
<PAGE>   27

        Doran G. Machin has served as a director since 1987. Mr. Machin was also
our Secretary and Executive Vice President from 1987 through April, 1999. Prior
to 1987, Mr. Machin was employed as an independent computer consultant, worked
for Hewlett-Packard and American Data Industries. Mr. Machin attended Cerritos
College and California State University, Fullerton.

        Jerry Murdock, Jr. has served as a member of our board since April 1999.
Since 1995, Mr. Murdock has been employed by InSight Capital Partners, an
investment firm which he co-founded in that year. From 1987 to 1995, Mr. Murdock
was President of Aspen Technology Group, a consulting firm which he founded in
1987. Mr. Murdock has a degree in Political Science from San Diego State
University. Mr. Murdock is a member of the boards of directors of several
private technology companies.

ITEM 11. EXECUTIVE COMPENSATION

        Information required by this item will be included in the Company's
proxy statement, to be delivered to shareholders in connection with the
Company's annual meeting of shareholders to be held on May 16, 2000. Such
information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        Information required by this item will be included in the Company's
proxy statement, to be delivered to shareholders in connection with the
Company's annual meeting of shareholders to be held in May 16, 2000. Such
information is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Information required by this item will be included in the Company's
proxy statement, to be delivered to shareholders in connection with the
Company's annual meeting of shareholders to be held in May 16, 2000. Such
information is incorporated herein by reference.


                                       25
<PAGE>   28

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1. FINANCIAL STATEMENTS

        The following consolidated financial statements, and related notes
thereto, of the Company and the Report of Independent Auditors are filed as part
of this Form 10-K.

<TABLE>
<CAPTION>
                                                                                                      PAGE
                                                                                                      ----
<S>                                                                                                   <C>
  Independent Auditors' Report ..................................................................      F-1
  Consolidated Balance Sheets as of December 31, 1998 and 1999 ..................................      F-2
  Consolidated Statements of Income for the Years Ended December 31, 1997, 1998 and 1999 ........      F-3
  Consolidated Statements of Shareholders' Equity for the Years Ended
     December 31, 1997, 1998 and 1999 ...........................................................      F-4
  Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999 ....      F-5
  Notes to Consolidated Financial Statements ....................................................      F-6
</TABLE>

    2. FINANCIAL STATEMENT SCHEDULES

        The financial statement schedules required by Regulation S-X are listed
in Item 14(d) of this Annual Report on Form 10-K.

    3. EXHIBITS

        The Exhibits filed as part of this Annual Report are listed in Item
14(c) of this Annual Report on Form 10-K.

(b) REPORTS ON FORM 8-K

        The Company filed a report on Form 8-K on November 18, 1999 as amended
on December 29, 1999 with respect to the Company's acquisition of MBR
Technologies, Inc.

        The Company filed a report on Form 8-K on November 24, 1999 with respect
to the Company's acquisition of Foglight Software, Inc.

(c) EXHIBITS

        The following exhibits are filed as part of , or are incorporated by
reference in, this Report.

<TABLE>
     EXHIBIT
     NUMBER                        EXHIBIT TITLE
     ------                        -------------
<S>               <C>
     3.1 **       Second Amended and Restated Articles of Incorporation.

     3.2 *****    Second Amended and Restated Bylaws, as amended.

     4.1 **       Form of Registrant's Specimen Common Stock Certificate.

    10.1 **++     Registrant's 1998 Stock Option/Stock Issuance Plan.

    10.2 **++     Registrant's 1999 Stock Incentive Plan.

    10.3 **++     Registrant's 1999 Employee Stock Purchase Plan.

    10.4 **       Form of Directors' and Officers' Indemnification Agreement.

    10.5 **       Securities Purchase Agreement, dated as of April 21, 1999,
                  by and among Quest Software, Inc. and InSight Capital Partners
                  II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS
                  Capital LLC, and WI Software Investors LLC.

    10.6**        Investors' Rights Agreement dated as of April 21, 1999
                  among Quest Software, Inc. and InSight Capital Partners II,
                  L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital
                  LLC, and WI Software Investors LLC.

    10.7+**       Agreement, dated February 19, 1999, between Quest
                  Software, Inc. and INSO Chicago Corporation, dba INSO
                  Corporation.
</TABLE>

                                       26
<PAGE>   29

<TABLE>
<CAPTION>
<S>               <C>
    10.8+**       OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc.

    10.9 **       Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest
                  Software, Inc.

    10.10*****    Office Lease between The Northwestern Mutual Life
                  Insurance Company (Landlord) and Quest Software, Inc. (Tenant)
                  dated as of September 30, 1999.

    10.11+*****   Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight
                  Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software,
                  Inc.

    10.12***      Agreement and Plan of Merger dated as of November 2, 1999,
                  as amended, by and among Quest, Quest Merger Corporation, MBR
                  Technologies, Inc., and certain shareholders of MBR
                  Technologies, Inc.

    10.13****     Agreement and Plan of Merger dated as of November 10,
                  1999, by and among Quest, Quest Acquisition Corporation II,
                  Inc., and Foglight Software, Inc.

    23.1          Consent of Deloitte & Touche LLP.

    27.1          Financial Data Schedule (In electronic format only).
</TABLE>

----------

**     Incorporated by reference herein to the Company's Registration Statement
       on Form S-1 and all amendments thereto (File No. 333-80543).

***    Incorporated by reference herein to the Form 8-K and all amendments
       thereto filed with the Securities and Exchange Commission on December 29,
       1999.

****   Incorporated by reference herein to the Form 8-K and all amendments
       thereto filed with the Securities and Exchange Commission on January 21,
       2000.

*****  Incorporated by reference herein to the Company's Registration Statement
       on Form S-1 and all amendments thereto (File No. 333-30816).

+      Confidential treatment requested and received as to certain portions of
       this agreement.

++     Indicates a management contract or compensatory arrangement.


                                       27
<PAGE>   30

(d) FINANCIAL STATEMENT SCHEDULE

                 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNT

<TABLE>
<CAPTION>
                                       BALANCE AT   CHARGES,                  BALANCE AT
                                       BEGINNING    COSTS AND                   END OF
           DESCRIPTION                 OF PERIOD    EXPENSES    DEDUCTIONS      PERIOD
----------------------------------      -------      -------      -------       -------
<S>                                    <C>          <C>         <C>           <C>
Year ended
December 31, 1997:
  Allowance for doubtful
    accounts and sales returns ...      $   546      $   584      $  (347)      $   783


Year ended December 31, 1998:
  Allowance for doubtful
    accounts and sales returns ...      $   783      $ 1,116      $  (847)      $ 1,052


Year ended December 31, 1999:
  Allowance for doubtful
    accounts and sales returns ...      $ 1,052      $ 5,451      $(3,264)      $ 3,239
</TABLE>

        All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission have been
omitted because they are not required under the related instructions or are
inapplicable, or because the information has been provided in the Consolidated
Financial Statements or Notes thereto.


                                       28
<PAGE>   31

                          INDEPENDENT AUDITORS' REPORT

The Shareholders and Board of Directors
Quest Software, Inc.

        We have audited the accompanying consolidated balance sheets of Quest
Software, Inc. and subsidiaries (the Company) as of December 31, 1998 and 1999,
and the related consolidated statements of income, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

        We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly,
in all material respects, the consolidated financial position of Quest Software,
Inc. and its subsidiaries at December 31, 1998 and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Costa Mesa, California
February 1, 2000 (except for
Note 12 as to which the date
is March 9, 2000)


                                      F-1
<PAGE>   32

                              QUEST SOFTWARE, INC.

                           CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                       -----------------------
                                                                         1998           1999
                                                                       --------       --------
<S>                                                                    <C>            <C>
ASSETS

Current assets:
  Cash and cash equivalents .....................................      $  8,981       $ 39,643
  Short-term marketable securities, available for sale ..........            --         11,000
  Accounts receivable, net of allowance for doubtful
     accounts and sales returns of $1,052 (1998) and $3,239
     (1999) .....................................................         7,443         18,771
  Prepaid expenses and other current assets .....................           720          3,244
  Deferred income taxes .........................................           198          2,089
                                                                       --------       --------
       Total current assets .....................................        17,342         74,747
Property and equipment, net .....................................         1,388          7,179
Long-term marketable securities, available for sale .............            --          4,484
Purchased technology and software licenses, net .................           527            441
Goodwill, net ...................................................            --         11,452
Deferred income taxes ...........................................           267            415
Other assets ....................................................           121            431
                                                                       --------       --------
                                                                       $ 19,645       $ 99,149
                                                                       ========       ========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Accounts payable ..............................................      $  1,468       $  3,436
  Accrued compensation ..........................................         1,937          4,966
  Other accrued expenses ........................................         2,243          7,062
  Income taxes payable ..........................................            --          2,030
  Deferred support revenue ......................................         7,298         13,932
  Deferred license revenue ......................................         1,625          4,651
                                                                       --------       --------
       Total current liabilities ................................        14,571         36,077
Long-term liabilities ...........................................            --            403

Commitments and contingencies (Note 9)

Shareholders' equity:
  Preferred stock, no par value, 5,000 shares authorized; no
     shares issued or outstanding ...............................            --             --
  Common stock, no par value, 75,000 shares authorized;
     44,538 and 38,905 shares issued and outstanding at
     December 31, 1998 and 1999 .................................         4,241         94,010
Retained earnings ...............................................         3,991          1,864
Accumulated other comprehensive income (loss) ...................            --            (26)
Notes receivable from sale of common stock ......................        (3,158)        (3,115)
Capital distribution in excess of basis in common stock .........            --        (30,064)
                                                                       --------       --------
       Total shareholders' equity ...............................         5,074         62,669
                                                                       --------       --------
                                                                       $ 19,645       $ 99,149
                                                                       ========       ========
</TABLE>

See accompanying notes to consolidated financial statements.



                                      F-2
<PAGE>   33

                              QUEST SOFTWARE, INC.

                        CONSOLIDATED STATEMENTS OF INCOME
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                        YEAR ENDED DECEMBER 31,
                                                                                -------------------------------------
                                                                                 1997           1998          1999
                                                                                --------       --------      --------
                                                                               (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S>                                                                             <C>            <C>           <C>
                 Revenues:
                   Licenses ..............................................      $ 12,158       $ 24,901      $ 54,269
                   Services ..............................................         6,157          9,889        16,599
                                                                                --------       --------      --------
                        Total revenues ...................................        18,315         34,790        70,868

                 Cost of revenues:
                   Licenses ..............................................         1,307          3,433         2,998
                   Services ..............................................         1,972          2,507         4,195
                                                                                --------       --------      --------
                        Total cost of revenues ...........................         3,279          5,940         7,193
                                                                                --------       --------      --------
                 Gross profit ............................................        15,036         28,850        63,675

                 Operating expenses:
                   Sales and marketing ...................................         5,845         11,836        32,078
                   Research and development ..............................         4,293          8,047        15,980
                   General and administrative ............................         3,450          5,278         9,906
                   Other compensation costs and goodwill amortization ....            --             --         1,243
                                                                                --------       --------      --------
                        Total operating expenses .........................        13,588         25,161        59,207
                                                                                --------       --------      --------
                 Income from operations ..................................         1,448          3,689         4,468
                 Other (expense) income, net .............................          (137)           336         1,202
                                                                                --------       --------      --------
                 Income before income tax provision ......................         1,311          4,025         5,670
                 Income tax provision ....................................         1,022          1,679         2,273
                                                                                --------       --------      --------
                 Net income ..............................................      $    289       $  2,346         3,397
                                                                                ========      ========
                 Preferred stock dividends ...............................                                        590
                                                                                                             --------
                 Net income applicable to common shareholders ............                                   $  2,807
                                                                                                             ========
                 Basic and diluted net income per share ..................      $   0.01       $   0.05      $   0.07
                 Pro forma basic net income per share (Note 12) ..........      $     --       $   0.03      $   0.04
                 Pro forma diluted net income per share (Note 12) ........      $     --       $   0.03      $   0.03

                 Weighted average shares outstanding:
                   Basic .................................................        40,373         44,261        37,677
                   Diluted ...............................................        40,617         44,459        41,800
                   Pro forma basic (Note 12) .............................        80,746         88,522        75,354
                   Pro forma diluted (Note 12) ...........................        81,234         88,918        83,600
</TABLE>

See accompanying notes to consolidated financial statements.



                                      F-3
<PAGE>   34

                              QUEST SOFTWARE, INC.

                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                         CAPITAL
                                                                                                       DISTRIBUTION
                                                                           ACCUMULATED     NOTES       IN EXCESS OF
                                            COMMON STOCK                     OTHER       RECEIVABLE      BASIS IN       TOTAL
                                     -----------------------  RETAINED    COMPREHENSIVE     FROM          COMMON     SHAREHOLDERS'
                                      SHARES         AMOUNT   EARNINGS    INCOME (LOSS)  SHAREHOLDERS      STOCK        EQUITY
                                     --------       --------  --------      --------       --------       --------     --------
<S>                                  <C>            <C>       <C>         <C>            <C>           <C>           <C>
BALANCE, January 1, 1997 .......       39,000       $    812  $  1,617      $     --       $     --       $     --     $  2,429
Issuance of common stock .......          597            413        --            --             --             --          413
Note receivable from
  shareholder for purchase of
  common stock .................        3,900          2,200        --            --         (2,200)            --           --
Accrued interest receivable
  from shareholder .............           --             --        --            --            (34)            --          (34)
Net income .....................           --             --       289            --             --             --          289
Distributions paid .............           --             --      (261)           --             --             --         (261)
                                     --------       --------  --------      --------       --------       --------     --------
BALANCE, December 31, 1997 .....       43,497          3,425     1,645            --         (2,234)            --        2,836
Issuance of common stock .......           66             66        --            --             --             --           66
Note receivable from
  shareholder for purchase of
  common stock .................          975            750        --            --           (750)            --           --
Accrued interest receivable
  from shareholders ............           --             --        --            --           (174)            --         (174)
Net income .....................           --             --     2,346            --             --             --        2,346
                                     --------       --------  --------      --------       --------       --------     --------
BALANCE, December 31, 1998 .....       44,538          4,241     3,991            --         (3,158)            --        5,074
                                     --------       --------  --------      --------       --------       --------     --------
Exercise of stock options,
  including tax benefit ........           34            201        --            --             --             --          201
Payment on notes receivable
  from shareholders for
  purchase of common stock .....           --             --        --            --            230             --          230
Accrued interest receivable
  from shareholders ............           --             --        --            --           (187)            --         (187)
Repurchase of common stock .....      (14,820)            (2)   (4,934)           --             --        (30,064)     (35,000)
Conversion of Series A
  Redeemable Preferred Stock
  to common stock ..............        4,000         15,000        --            --             --             --       15,000
Issuance of common stock in
  the initial public
  offering, net ................        5,060         64,856        --            --             --             --       64,856
Compensation expense
  associated with stock
  option grants ................           --            432        --            --             --             --          432
Common stock issued for an
  acquisition, net (Note 2) ....           93          9,282        --            --             --             --        9,282
Dividends on Series B
  Redeemable Preferred
  Stock ........................           --             --      (590)           --             --             --         (590)
Unrealized loss on
  available-for-sale
  securities ...................           --             --        --           (26)            --             --          (26)
Net income .....................           --             --     3,397            --             --             --        3,397
                                                                                                                       --------
Comprehensive income ...........           --             --        --            --             --             --        3,371
                                     --------       --------  --------      --------       --------       --------     --------
BALANCE, December 31, 1999 .....       38,905       $ 94,010  $  1,864      $    (26)      $ (3,115)      $(30,064)    $ 62,669
                                     ========       ========  ========      ========       ========       ========     ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       F-4
<PAGE>   35

                              QUEST SOFTWARE, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                               YEAR ENDED DECEMBER 31,
                                                                                       --------------------------------------
                                                                                         1997          1998           1999
                                                                                       --------       --------       --------
<S>                                                                                    <C>            <C>            <C>
Cash flows from operating activities:

  Net income ....................................................................      $    289       $  2,346       $  3,397
  Adjustments to reconcile net income to net cash provided
    by operating activities:
      Depreciation and amortization .............................................           964          1,893          2,107
      Compensation expense associated with stock option
       grants ...................................................................            --             --            432
      Loss from disposal of property and equipment ..............................            52             --             --
      Accrued interest receivable from shareholders .............................           (34)          (174)          (187)
      Deferred income taxes .....................................................           178           (643)        (1,667)
      Changes in assets and liabilities, net of effects of
       acquisitions:
         Accounts receivable ....................................................          (683)        (2,628)       (11,441)
         Income taxes receivable ................................................          (122)           122             --
         Prepaid expenses and other current assets ..............................           282           (620)        (2,527)
         Other assets ...........................................................            38              5           (288)
         Accounts payable .......................................................           113            941          1,974
         Bank overdraft .........................................................          (393)            --             --
         Accrued compensation ...................................................           108          1,162          2,544
         Other accrued expenses .................................................           881          1,141          5,366
         Income taxes payable ...................................................            --             --          2,218
         Deferred revenue .......................................................         1,960          4,636          9,449
                                                                                       --------       --------       --------
         Net cash provided by operating activities ..............................         3,633          8,181         11,377
Cash flows from investing activities:
  Purchases of property and equipment ...........................................          (536)        (1,231)        (7,143)
  Purchases of software licenses ................................................          (831)           (57)          (350)
  Cash received (paid) for acquisitions, net of cash
    acquired ....................................................................           100             --         (1,094)
  Purchases of marketable securities ............................................            --             --        (15,510)
  Sales and maturities of marketable securities .................................            --             --             --
                                                                                       --------       --------       --------
         Net cash used in investing activities ..................................        (1,267)        (1,288)       (24,097)
Cash flows from financing activities:
  Distributions to shareholders .................................................          (261)            --             --
  Proceeds from note payable ....................................................            --             --         10,000
  Repayment of notes payable ....................................................            --             --        (10,918)
  Repayment of capital lease obligations ........................................            --             --            (36)
  Proceeds from issuance of preferred stock .....................................            --             --         25,000
  Redemption of Series B Redeemable Preferred Stock .............................            --             --        (10,000)
  Repurchase of common stock ....................................................            --             --        (35,000)
  Net proceeds from the sale of common stock ....................................            --             --         64,856
  Proceeds from the exercise of stock options ...................................            --             --             33
  Repayment of note payable to related party ....................................            (9)            (8)            (8)
  Payment on notes receivable from shareholders for purchase of common stock ....            --             --            230
  Cash dividends paid on Series B Redeemable Preferred Stock ....................            --             --           (590)
                                                                                       --------       --------       --------
         Net cash (used in) provided by financing activities ....................          (270)            (8)        43,567
Effect of exchange rate changes on cash and cash equivalents ....................            --             --           (185)
                                                                                       --------       --------       --------
Net increase in cash and cash equivalents .......................................      $  2,096       $  6,885       $ 30,662
Cash and cash equivalents, beginning of period ..................................            --          2,096          8,981
                                                                                       --------       --------       --------
Cash and cash equivalents, end of period ........................................      $  2,096       $  8,981       $ 39,643
                                                                                       ========       ========       ========
Supplemental disclosures of consolidated cash flow information:
  Cash paid during the year for:
    Interest ....................................................................      $      8       $      5       $    240
                                                                                       ========       ========       ========
    Income taxes ................................................................      $    938       $  2,054       $  1,874
                                                                                       ========       ========       ========
Supplemental schedule of noncash investing and financing activities:
  Note receivable from shareholders for purchase of common stock ................      $  2,200       $    750
                                                                                       ========       ========
  Conversion of Series A Preferred Stock to Common Stock ........................                                    $ 15,000
                                                                                                                     ========
  Tax benefit related to stock option exercises .................................                                    $    168
                                                                                                                     ========
  Unrealized loss on available-for-sale securities ..............................                                    $     26
                                                                                                                     ========
</TABLE>

See Note 2 for details of assets acquired and liabilities assumed in purchase
transactions.

See accompanying notes to consolidated financial statements.



                                      F-5
<PAGE>   36

                              QUEST SOFTWARE, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                     (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

        Nature of Operations -- Quest Software, Inc., a California corporation,
(the Parent) and its subsidiaries (collectively the Company) provide application
and information availability software solutions that enhance the performance and
reliability of an organization's e-business, packaged and custom applications,
and enable the delivery of information across the entire enterprise. The Company
also provides consulting, training, and support services to its customers. The
accompanying consolidated financial statements include the accounts of the
Parent and its wholly owned subsidiaries in Australia, the United Kingdom,
Germany, Israel, and Ireland. All significant intercompany transactions and
balances have been eliminated in consolidation.

        Stock Split -- On June 23, 1998, the Company's Board of Directors
approved and effected a 1,300-for-1 stock split of the Company's common stock,
and on March 10, 1999, the Company's Board of Directors approved and effected a
2-for-1 stock split. On June 4, 1999, in connection with the public offering of
the Company's common stock, the Company's Board of Directors approved and
effected a 3-for-2 stock split of the Company's common stock. All share, per
share and conversion amounts relating to common stock, preferred stock, and
stock options included in the accompanying consolidated financial statements and
footnotes have been restated to reflect the stock splits and for all periods
presented.

        Foreign Currency Translation -- In accordance with Statement of
Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation, the
United States dollar is considered to be the functional currency for the
Company's foreign subsidiaries, as such subsidiaries act as sales offices for
the Parent. Therefore, gains or losses from translation adjustments are included
in other income in the Company's consolidated statements of operations.
Translation adjustments were not material for the years ended December 31, 1997,
1998 and 1999. However, due to the increase in international operations, the
Company's results of operations could be impacted in the future.

        Fair Value of Financial Instruments -- The Company's consolidated
balance sheets include the following financial instruments: cash, accounts
receivable, notes receivable, accounts payable, and accrued liabilities. The
Company considers the carrying value of cash, accounts receivable, accounts
payable, and accrued liabilities in the consolidated financial statements to
approximate fair value for these financial instruments because of the relatively
short period of time between origination of the instruments and their expected
realization. Based on borrowing rates currently available, the fair value of the
notes receivable from the sale of common stock at December 31, 1999, was
approximately $3,669.

        Cash and Cash Equivalents -- Cash equivalents include short-term, highly
liquid investments with original maturities of three months or less. Interest
income, included in other income (expense) in the accompanying consolidated
statements of operations, was, $72, $372, and $1,514 for the years ended
December 31, 1997, 1998 and 1999, respectively.

        Accounts Receivable -- The Company sells and/or licenses its products
and services to various companies across several industries. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. The Company maintains reserves for potential credit losses
and sales returns.

        Investments -- The Company has classified all debt securities with
original maturities of greater than three months as available-for-sale.
Available-for-sale securities are carried at fair value, with unrealized gains
and losses reported as a separate component of 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.

        As of December 31, 1999, the Company had available-for-sale debt
securities with a fair market value of $15,484 and a cost basis of $15,510. The
unrealized loss of $26 has been recorded as a separate component of
shareholders' equity, and consisted of five positions, all with unrealized
losses.


                                      F-6
<PAGE>   37

        Property and Equipment -- Property and equipment are stated at cost.
Depreciation and amortization are provided using the straight-line method over
the estimated useful lives ranging from three to seven years. Leasehold
improvements are amortized over the shorter of the estimated useful lives of the
improvements or the term of the related lease. Repair and maintenance costs are
expensed as incurred.

        Long-Lived Assets -- The Company accounts for the impairment and
disposition of long-lived assets in accordance with SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
In accordance with SFAS No. 121, long-lived assets to be held are reviewed for
events or changes in circumstances which indicate that their carrying value may
not be recoverable. The Company periodically reviews the carrying value of
long-lived assets to determine whether or not an impairment to such value has
occurred. At December 31, 1998 and 1999, there was no impairment of long-lived
assets.

        Purchased Technology and Software Licenses -- Purchased technology is
recorded either at cost or, for amounts related to acquisitions, at appraised
value and amortized using the straight-line method over estimated useful lives
of three years to five years. Accumulated amortization was $1,483, $1,638 and
$1,777 at December 31, 1997, 1998, and 1999, respectively. Software licenses are
recorded at cost and are amortized over the shorter of the estimated useful
lives of the related products or the term of the license. Accumulated
amortization was $644, $871 and $1,027 at December 31, 1997, 1998 and 1999,
respectively. The net carrying amount of purchased technology and software
licenses was considered recoverable at December 31, 1998 and 1999, based on the
undiscounted future cash flows expected to be realized from continued sales of
the related software products.

        Other Assets -- Other assets include amounts receivable related to a
settlement agreement the Company entered into with a former employee. Under the
terms of the settlement agreement, the Company received a lump-sum payment
totaling $220 in January 1997, and a promissory note providing for 40 monthly
payments of $4 each commencing March 1, 1997. Approximately $63 and $25 of the
settlement receivable is recorded in other current assets in the accompanying
consolidated financial statements at December 31, 1998 and 1999, respectively.

        Goodwill -- Goodwill arising from acquisitions (Note 2) is amortized on
a straight-line basis over five years. The Company will annually evaluate the
carrying value of goodwill for impairment of value based on undiscounted future
cash flows.

        Capital Distribution in Excess of Basis in Common Stock -- In connection
with the repurchase of common stock in April 1999 from a major shareholder (Note
4) the excess of the repurchase price over the original cost of the shares has
been recorded as a capital distribution in excess of the basis of the common
stock in the accompanying consolidated financial statements.

        Revenue Recognition -- During October 1997, the Financial Accounting
Standards Board (FASB) issued Statement of Position (SOP) 97-2, Software Revenue
Recognition, which provides guidance in recognizing revenue on software
transactions. SOP 97-2 is effective for transactions entered into in fiscal
years beginning after December 15, 1997, and supersedes SOP 91-1. The Company
adopted this statement, as amended, for the year ended December 31, 1998, and
such adoption did not have any impact on the Company's results of operations.

        Software Licenses, Services, and Post-Contract Customer Support --
Revenues from sales of software licenses, which generally do not contain
multiple elements, are recognized upon shipment of the related product if the
requirements of SOP 97-2, as amended, are met. If the requirements of SOP 97-2,
including evidence of an arrangement, customer acceptance, a fixed or
determinable fee, collectibility or vendor-specific objective evidence about the
value of an element are not met at the date of shipment, revenue recognition is
deferred until such items are known or resolved. Amounts recorded at December
31, 1998 and 1999 for deferred license revenue represent sales in which the
Company has received some payments, but all of the requirements of SOP 97-2 have
not been met. Revenue from service and post-contract customer support is
deferred and recognized ratably over the term of the contract.

        Software Development Costs -- Costs incurred in the research and
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. After technological feasibility is established, any additional
costs are capitalized in accordance with SFAS No. 86, Accounting for the Costs
of Computer Software to Be Sold, Leased or Otherwise Marketed. Because the
Company believes that its current process for developing software is essentially
completed concurrently with the establishment of technical feasibility, no
software development costs have been capitalized as of December 31, 1998 and
1999.

        Advertising Expenses -- Advertising expenses were $300, $594 and $998
for the years ended December 31, 1997, 1998 and 1999, respectively.



                                      F-7
<PAGE>   38

        Income Taxes -- The Company accounts for its income taxes under the
provisions of SFAS No. 109, Accounting for Income Taxes. Deferred taxes on
income result from temporary differences between the reporting of income for
financial statements and tax reporting purposes. Measurement of the deferred
items is based on enacted tax laws. In the event the future consequences of
differences between financial reporting bases and tax bases of the Company's
assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an
evaluation of the probability of being able to realize the future benefits
indicated by such asset. A valuation allowance related to a deferred tax asset
is recorded when it is more likely than not that some portion or all of the
deferred tax asset will not be realized.

        Stock-Based Compensation -- The Company accounts for stock-based awards
to employees, using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.

        Net Income Per Share -- The Company computes net income per share in
accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is
computed by dividing net income available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution of securities by including other common
stock equivalents, including stock options, in the weighted average number of
common shares outstanding for a period, if dilutive.

        For the year ended December 31, 1999, net income applicable to common
shareholders was $2,807 representing net income for the year of $3,397 less
Preferred Stock dividends of $590 associated with the Series B Redeemable
Preferred Stock (Note 7).

        The table below sets forth the reconciliation of the denominator of the
earnings per share calculation:

<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31,
                                                                ------------------------------
                                                                 1997        1998        1999
                                                                ------      ------      ------
<S>                                                             <C>         <C>         <C>
Shares used in computing basic net income per share ......      40,373      44,261      37,677
Conversion of Series A Preferred Stock ...................          --          --       1,238
Dilutive effect of stock options .........................         244         198       2,885
                                                                ------      ------      ------
Shares used in computing diluted net income per share ....      40,617      44,459      41,800
                                                                ======      ======      ======
</TABLE>

        The conversion of the Series A Preferred Stock into common stock
reflects the weighted average of such shares per SFAS No. 128.

        Comprehensive Income -- For the year ended December 31, 1998, the
Company adopted SFAS No. 130, Reporting Comprehensive Income. There was no
difference between the net income and the comprehensive net income for the years
ended December 31, 1997 and 1998. For the year ended December 31, 1999, the
difference between net income and comprehensive net income was an unrealized
loss for available-for-sale securities of $26.

        Use of Estimates -- The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

        Risks and Uncertainties -- The Company is subject to risks and
uncertainties in the normal course of business, including customer acceptance of
its products, rapid technological changes, delays in introducing and market
acceptance of new products, competition, e-business developments, the impact of
the Year 2000, international expansion, ability to attract and retain qualified
personnel, ability to protect its intellectual property, and other matters
inherent in the software industry.

NEW ACCOUNTING PRONOUNCEMENTS:

        The Company has adopted SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information. In accordance with SFAS No. 131, the Company
has disclosed in Note 10 certain information about operating segments and
certain information about the Company's revenue types, geographic areas to which
the Company sells its products, and major customers.

        In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which the Company is required to adopt
effective in its fiscal year 2001. SFAS No. 133 will require the Company to
record all derivatives on the balance sheet at fair value. The Company does not
currently engage in hedging activities but will continue to evaluate the effects
of adopting SFAS No. 133.


                                      F-8
<PAGE>   39

2. ACQUISITIONS

        On April 12, 1996, through a majority-owned subsidiary in the United
Kingdom, the Company acquired certain net assets of System Software
International Limited (SSI). The acquisition was accounted for under the
purchase method of accounting, and the purchase price of approximately $119 was
allocated to net assets of $30 and goodwill of $89. At December 31, 1996,
expected future undiscounted cash flows from SSI did not support the
recoverability of the goodwill resulting in the write-off of the remaining
unamortized balance. In March 1997, the Company elected to discontinue funding
the subsidiary, and in July 1997 commenced liquidation proceedings. During the
year ended December 31, 1999, the liquidation was completed without a material
loss to the Company.

        On May 1, 1997, the Company entered into an agreement to acquire the net
assets of Common Sense Computing Pty. Ltd. (CSC) for 663 shares of the Company's
common stock. At the closing date, 597 shares valued at $413 were issued to the
seller, with the remaining 66 shares to be issued in June 1998, provided that
the seller performed certain obligations under the indemnification provisions in
the agreement. The acquisition was accounted for under the purchase method of
accounting and the purchase price was allocated $320 to technology rights based
upon the estimated fair value at the date of acquisition, $53 to property, plant
and equipment, $100 to cash, and $60 to liabilities assumed. CSC's operating
results have been included in the Company's financial statements from the date
of acquisition. On June 15, 1998, the remaining 66 shares of common stock were
issued resulting in an allocation of an additional $66 to technology rights,
based on the fair market value of the Company's common stock at the time of
issuance.

        On July 1, 1999, the Company, through its wholly owned subsidiaries in
Israel and Ireland, acquired certain assets of Neptune Software Ltd. for a cash
payment of $484. The acquisition was accounted for under the purchase method of
accounting and the purchase price was allocated to net assets of $474 and
goodwill of $10.

        On December 17, 1999, the Company, through its wholly owned subsidiary,
acquired all of the outstanding common stock and stock options of MBR
Technologies, Inc. (MBR) in exchange for 93 shares of the Company's common stock
valued at $9,324, a cash payment of $1,314, and the assumption of net
liabilities of $340, including a note payable to Quest of $507. The acquisition
was accounted for as a purchase and the purchase price of $10,750, which
included $112 of direct acquisition costs, was allocated as follows:

<TABLE>
<CAPTION>
<S>                                                                  <C>
        Current assets...........................................    $     308
        Deferred taxes...........................................          339
        Fixed assets.............................................          123
        Goodwill.................................................       11,534
        Liabilities assumed......................................       (1,110)
        Acquisition liabilities..................................         (444)
                                                                     ---------
             Total purchase price................................    $  10,750
                                                                     =========
</TABLE>

        The acquisition liabilities consist of $36 related to the buyout of an
operating lease and $408 related to the cost of an abandoned lease on MBR's
facility reduced by the monthly lease costs up to the date of abandonment. MBR's
operating results have been included in the Company's financial statements from
the date of acquisition. Goodwill will be amortized on a straight-line basis
over five years.

        The following unaudited pro forma condensed consolidated results of
operations assumes that the MBR acquisition had occurred on the first day of the
Company's fiscal year ended December 31, 1998. The pro forma condensed
consolidated results of operations, presented for information purposes only, is
based on historical information and does not necessarily reflect the actual
results that would have occurred, nor is it necessarily indicative of future
results of the combined enterprise.

<TABLE>
<CAPTION>
                                   YEARS ENDED
                                   DECEMBER 31,
                              -----------------------
                                1998           1999
                              --------       --------
<S>                           <C>            <C>
Net revenues ...........      $ 35,058       $ 71,438
Net loss ...............      $   (512)      $    (72)
Net loss per share:
  Basic and diluted ....      $  (0.01)      $  (0.00)
</TABLE>


                                      F-9
<PAGE>   40

        In connection with the employment of certain of the MBR shareholders by
Quest, bonus payments of up to $6,000 could be earned over a two-year period
ending in 2002 if certain sales of MBR products, based on a formula, exceed
$4,000 and $8,000. Such bonus payments, if any, will be recorded as compensation
expense when and if such bonuses are earned.

        On January 7, 2000, the Company, through its wholly owned subsidiary,
acquired all of the outstanding common stock of Foglight Software, Inc. in
exchange for 1,188 shares of the Company's common stock valued at $104,168, cash
payments estimated to be $437, the assumption of unvested Foglight stock options
valued at $2,200 and the assumption of net liabilities estimated to be $4.1
million. The acquisition will be accounted for as a purchase and the purchase
price, including $193 of direct acquisition costs will be allocated primarily to
goodwill and intangible assets which will be amortized over two to five years.
Quest also had notes receivable from Foglight of $1,308 at December 31, 1999.

        On February 1, 2000, the Company, through a wholly owned subsidiary,
acquired all of the outstanding common stock of QMaster Software Solutions
(QMaster) for a cash payment of $15,000 including an estimated $75 in direct
acquisition costs. The acquisition was accounted for as a purchase and the
purchase price is expected to be allocated primarily to goodwill and other
intangible assets.

3. PROPERTY AND EQUIPMENT

        Net property and equipment consist of the following at December 31:

<TABLE>
<CAPTION>
                                                          1998          1999
                                                         -------       -------
<S>                                                      <C>           <C>
Furniture and fixtures ............................      $   596       $ 2,262
Machinery and equipment ...........................          270           758
Computer equipment ................................        1,711         5,311
Computer software .................................          315           692
Leasehold improvements ............................          109           407
                                                         -------       -------
                                                           3,001         9,430
Less accumulated depreciation and amortization ....       (1,613)       (2,251)
                                                         -------       -------
Property and equipment, net .......................      $ 1,388       $ 7,179
                                                         =======       =======
</TABLE>

4. RELATED-PARTY TRANSACTIONS

        In 1994, the Company borrowed $32 from a shareholder for the purchase of
certain fixed assets. The note payable bears interest at 8.5% per annum, payable
monthly, and requires monthly principal and interest payments of $1 through
December 31, 1999. Approximately $8 was included in other accrued expenses in
the accompanying consolidated financial statements representing the remaining
outstanding note payable balance at December 31, 1998. The remaining note
payable balance was repaid during 1999.

        During 1997, the Company received a note receivable from an officer of
the Company for the purchase of 3,900 shares of the Company's common stock at
$0.56 per share. The note receivable plus accrued interest is due April 2002 and
bears interest at 6.2%. The note receivable and accrued interest is secured by
the common stock.

        During 1998, the Company received a note receivable from another officer
of the Company for the purchase of 975 shares of the Company's common stock at
$0.77 per share. The note receivable plus accrued interest is due April 2003 and
bears interest at 5.7%. Up to 25% of the unpaid principal and accrued interest
may be repaid in each year during the four-year term of the note. The Company
has the option to repurchase any shares at the original issuance price
associated with the unpaid principal balance if the officer ceases to be
employed by the Company. All of the outstanding unpaid principal and interest
may be prepaid at any time when the current Chief Executive Officer of the
Company ceases to be employed or immediately prior to a sale of substantially
all of the assets of the Company or a merger in which the Company is not the
surviving entity. The note receivable and accrued interest is secured by the
common stock.

        In April 1999, the Company repurchased and cancelled 14,820 shares of
common stock from a shareholder of the Company at a price of $2.36 per share.
The Company also entered into a severance agreement with the shareholder whereby
the shareholder will receive $200 per year through 2001 and provides for use of
a company car and related expenses and medical benefits. The Company recorded
approximately $715 of expense related to the agreement in April 1999, which is
included in compensation and other costs in the accompanying consolidated
financial statements.



                                      F-10
<PAGE>   41
5. TERM NOTE

        In connection with the repurchase of common stock from a shareholder in
April 1999 (Note 4), the Company borrowed $10,000 under a term note with a bank.
The borrowings under the term note were secured by substantially all assets of
the Company, bore interest, at the Company's option, at either the bank's prime
rate or at the LIBOR rate plus a maximum of 2.75% per annum, required monthly
interest payments commencing June 1, 1999, and the principal was payable in 24
monthly installments of $417 commencing June 1, 2000. All unpaid principal and
interest was due on May 1, 2002. The loan contained covenants relating to
certain financial statement amounts related to tangible net worth, cash flow
from operations, and a debt to cash flow from operations and quick ratios. The
Company repaid the note after its initial public offering in August, 1999.

6. INCOME TAXES

        The provision for income taxes consists of the following for the years
ended December 31:

<TABLE>
<CAPTION>
                                                 1997         1998          1999
                                               -------       -------       -------
Current:
<S>                                            <C>           <C>           <C>
  Federal ...............................      $ 1,359       $ 1,819       $ 2,763
  State .................................          102           425           402
  Foreign ...............................           --            78           808
                                               -------       -------       -------
                                                 1,461         2,322         3,973
Deferred:
  Federal ...............................         (360)         (568)       (1,391)
  State .................................          (79)          (75)         (309)
  Foreign ...............................          (85)         (165)         (122)
                                               -------       -------       -------
                                                  (524)         (808)       (1,822)
Change in valuation allowance ...........           85           165           122
                                               -------       -------       -------
          Total income tax provision ....      $ 1,022       $ 1,679       $ 2,273
                                               =======       =======       =======
</TABLE>

     The reconciliation of income tax expense computed at U.S. federal statutory
rates to income tax expense for the years ended December 31, 1997, 1998 and
1999, is as follows:

<TABLE>
<CAPTION>
                                                          1997        1998        1999
                                                          ----        ----        ----
<S>                                                       <C>         <C>         <C>
Tax at U.S. federal statutory rates ................      35.0%       35.0%       35.0%
State taxes ........................................       2.0         5.7         1.1
Recording of deferred income tax liabilities in
  connection with the conversion to a C
  corporation ......................................      45.2          --          --
Foreign taxes ......................................       6.2         6.0         8.3
Research and development credits ...................      (10.4)      (4.6)       (4.7)
Other ..............................................        --        (0.4)        0.4
                                                          ----        ----        ----
                                                          78.0%       41.7%       40.1%
                                                          ====        ====        ====
</TABLE>

        Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred taxes as of December 31, 1998 and 1999, are
as follows:

<TABLE>
<CAPTION>
                                                            1998          1999
                                                           -------       -------
<S>                                                        <C>           <C>
Deferred tax assets:
  Accounts receivable and sales returns reserves ....      $   313       $   871
  Accrued liabilities ...............................          165           892
  Foreign net operating loss carryforwards ..........          250           127
  U.S. net operating loss carryforwards .............           --           339
  Intangible assets .................................          264           453
  Stock compensation ................................           --           184
  Other .............................................           56            --
                                                           -------       -------
Total gross deferred assets .........................        1,048         2,866
Deferred tax liabilities:
  Cash to accrual adjustment ........................         (301)         (150)
  State taxes .......................................          (32)          (47)
  Fixed assets ......................................           --           (38)
                                                           -------       -------
Total gross deferred liabilities ....................         (333)         (235)
Valuation allowance .................................         (250)         (127)
                                                           -------       -------
Net deferred income taxes ...........................      $   465       $ 2,504
                                                           =======       =======
Less current portion ................................         (198)       (2,089)
                                                           -------       -------
                                                           $   267       $   415
                                                           =======       =======
</TABLE>

                                      F-11
<PAGE>   42
        The Company has U.S. net operating loss carryforwards of $889 that are
subject to limitation by Internal Revenue Code Section 382 and begin to expire
in 2018. The Company has foreign net operating loss carryforwards of $425 that
can be carried forward indefinitely.

        Effective January 1, 1997, the Company converted to a C corporation and
became subject to regular federal and state income taxes on an ongoing basis. As
a result, the Company recorded $617 of net deferred income tax liabilities on
January 1, 1997.

        Total cash distributions charged against retained earnings include
payments of $261 in 1997, made to the Company's shareholders.

7. SHAREHOLDERS' EQUITY

        In April 1999, the Company issued 2,667 shares of Series A Preferred
Stock (Series A) for $15,000 and 1,778 shares of Series B Redeemable Preferred
stock (Series B) for $10,000.

        Series A shares were convertible at the holder's option into shares of
common stock, based on the conversion ratio defined in the agreement. The
conversion ratio could be adjusted, from time to time, in the event of certain
diluting events, as defined. Conversion was automatic in the event of a public
offering of the Company's common stock, that met certain specified criteria
initially at a rate of 1.5 shares of common stock for each share of preferred
stock. Additionally, the holders of not less than a majority of the Series A
shares had the right to redeem the Series A shares for cash in two equal
installments due on April 30, 2006 and 2007, respectively. The redemption price
would be determined on each date by the then applicable liquidation preference.
Upon the election of not less than a majority of the Series A holders to redeem
the Series A shares, all Series A shares would be redeemed. Dividends on Series
A were cumulative on a "when and as if declared" basis at a rate of 8% per share
per annum. Series A shareholders had the right to elect one director and have
veto rights over certain management decisions. In the event of liquidation,
dissolution or winding up of the Company, each Series A shareholder had a
liquidation preference equal to $5.625 per share, plus an amount equal to all
accrued but unpaid dividends, with respect to such shares plus an amount equal
to a prorated dividend from the last dividend payment date to the date fixed for
liquidation, dissolution, or winding up. In connection with the Company's
initial public offering in August 1999, all outstanding shares of Series A
Preferred Stock were converted into 4,000 shares of common stock.

        Series B shares were convertible into shares of Series A shares one year
after the issuance of the Series B shares at the holder's option based on the
ratio defined in the agreement. If the Series A shares were not converted into
common stock, Series B shares were convertible into shares of Series A preferred
stock at the Company's option prior to the one year anniversary of the date of
issuance of the Series B shares. The conversion ratio could be adjusted, from
time to time, in the event of certain diluting events, as defined. Dividends on
Series B were cumulative and could be declared at the discretion of the Board of
Directors. The dividend rate was 18% per share per annum. Series B shareholders
did not have voting rights with the exception of the redemption provisions
discussed below. In the event of liquidation, dissolution or winding up of the
Company, each Series B shareholder had a liquidation preference equal to $5.625
per share, plus an amount equal to all accrued but unpaid dividends, with
respect to such shares plus an amount equal to a prorated dividend from the last
dividend payment date to the date fixed for liquidation, dissolution, or winding
up. Additionally, the holders of the Series B shares and the Company had the
right to redeem the Series B shares for cash at any time one year following the
issuance of the Series B shares, or, if earlier, upon consummation of an initial
public offering. The redemption price was determined on the redemption date by
the then applicable liquidation preference. In connection with the Company's
initial public offering in August 1999, the Series B shares were redeemed for
$10,000 plus dividends of $590.

8. STOCK OPTION PLANS

        In connection with a prior acquisition, the Company entered into an
employment agreement with the president of the acquired company under which
options to purchase up to 2.5% of the Company's outstanding common stock at
$0.77 per share were granted. The agreement provided for issuance of additional
common shares to the individual in the event the Company issued common shares to
employees, subject to limitations as defined in the agreement. In connection
with the issuance of 975 shares of common stock to this individual in 1998 (Note
4), the option was cancelled.

        In May 1998, the Company adopted the 1998 Stock Option/Stock Issuance
Plan (the Plan). Under the terms of the Plan, options to purchase 7,500 shares
of the Company's common stock were reserved for issuance to employees,
directors, and consultants.


                                      F-12
<PAGE>   43

1999 STOCK INCENTIVE PLAN

        The 1999 Stock Incentive Plan is intended to serve as the successor
equity incentive program to the 1998 Stock Option/Stock Issuance Plan. The 1999
Stock Incentive Plan was adopted by the Board and subsequently approved by the
shareholders on June 9, 1999. The 1999 Stock Incentive Plan became effective
upon its adoption by the Board. On the date of the Company's initial public
offering, all outstanding options under the 1998 plan were incorporated into the
1999 Stock Incentive Plan, and no further option grants will thereafter be made
under the 1998 plan. The incorporated options will continue to be governed by
their existing terms, unless the plan administrator elects to extend one or more
features of the 1999 Incentive Plan to those options. Except as otherwise noted
below, the incorporated options have substantially the same terms as will be in
effect for grants made under the Discretionary Option Grant Program of the 1999
Stock Incentive Plan.

        Share Reserve -- At December 31, 1999, 7,478 shares of common stock have
been authorized for issuance under the 1999 Stock Incentive Plan of which 2,210
shares are available for issuance. The share reserve consists of the number of
shares that remain available for issuance under the 1998 plan and shares of
common stock subject to outstanding options thereunder. No participant in the
1999 Stock Incentive Plan may be granted stock options, separately exercisable
stock appreciation rights and direct stock issuances for more than 500 shares of
common stock in total per calendar year.

        Programs -- The 1999 Stock Incentive Plan is divided into five separate
programs:

    -   The discretionary option grant program under which eligible individuals
        may be granted options to purchase shares of common stock at an exercise
        price determined by the plan administrator;

    -   The stock issuance program under which individuals may be issued shares
        of common stock directly, through the purchase of such shares at a price
        determined by the plan administrator or as a bonus tied to the
        performance of services;

    -   The salary investment option grant program which may, at the plan
        administrator's discretion, be activated for one or more calendar years
        and, if so activated, will allow executive officers and other highly
        compensated employees the opportunity to apply a portion of their base
        salary to the acquisition of special below-market stock option grants;

    -   The automatic option grant program under which option grants will
        automatically be made at periodic intervals to eligible non-employee
        Board members to purchase shares of common stock at an exercise price
        equal to 100% of the fair market value of those shares on the grant
        date; and

    -   The director fee option grant program which may, in the plan
        administrator's discretion, be activated for one or more calendar years
        and, if so activated, will allow non-employee Board members the
        opportunity to apply a portion of the annual retainer fee otherwise
        payable to them in cash each year to the acquisition of special
        below-market option grants.

        Administration -- The discretionary option grant program and the stock
issuance program will be administered by the compensation committee of the Board
of Directors.

        Plan Features -- The 1999 Stock Incentive Plan includes the following
features:

    -   The exercise price for any options granted under the plan may be paid in
        cash or in shares of common stock valued at fair market value on the
        exercise date. The option may also be exercised through a same-day sale
        program without any cash outlay by the optionee.

    -   The compensation committee will have the authority to cancel outstanding
        options under the discretionary option grant program in return for the
        grant of new options for the same or different number of option shares
        with an exercise price per share based upon the fair market value of our
        common stock on the new grant date.

    -   Stock appreciation rights may be issued under the discretionary option
        grant program. Such rights will provide the holders with the election to
        surrender their outstanding options for an appreciation distribution
        from the Company equal to the fair market value of the vested shares of
        common stock subject to the surrendered option less the exercise price
        payable for those shares. Payment can be made in cash or in shares of
        common stock.

                                      F-13
<PAGE>   44

        Change in Control -- The 1999 Stock Incentive Plan includes the
following change in control provisions, which may result in the accelerated
vesting of outstanding option grants and stock issuances:

    -   In the event that the Company is acquired by merger or asset sale or a
        Board-approved sale of more than fifty percent of the then outstanding
        stock, each outstanding option under the discretionary option grant
        program which is not assumed or continued by the successor corporation
        will immediately become exercisable for all the option shares, and all
        unvested shares will immediately vest, except to the extent the
        Company's repurchase rights with respect to those shares are assigned to
        the successor corporation.

    -   The plan administrator will have complete discretion to grant one or
        more options which will become exercisable for all the option shares in
        the event those options are assumed in an acquisition, but the
        optionee's service with the Company or the acquiring entity is
        subsequently terminated. The vesting of outstanding shares under the
        1999 Stock Incentive Plan may be accelerated upon similar terms and
        conditions.

    -   The plan administrator may also grant options which will immediately
        vest upon our acquisition by another entity, whether or not those
        options are assumed by the successor corporation.

    -   The plan administrator may grant options and structure repurchase rights
        so that the shares subject to those options or repurchase rights will
        immediately vest in connection with a successful tender offer for more
        than 50% of the outstanding voting stock or a change in the majority of
        our board of directors through one or more contested elections. Such
        accelerated vesting may occur either at the time of such transaction or
        upon the subsequent termination of the individual's service.

        Salary Investment Option Grant Program -- In the event the compensation
committee decides to put this program into effect for one or more calendar
years, each of the Company's executive officers and other highly compensated
employees selected for participation may elect to reduce his or her base salary
for that calendar year by a specified dollar amount not less than $10 nor more
than $75. Each selected individual who makes such an election will automatically
be granted, on the first trading day in January of the calendar year for which
that salary reduction is to be in effect, an option to purchase that number of
shares of common stock determined by dividing the salary reduction amount by
two-thirds of the fair market value per share of common stock on the grant date.
Compensation expense will be recorded for the amount of the salary reduction.
The option will be exercisable at a price per share equal to one-third of the
fair market value of the option shares on the grant date. As a result, the total
spread on the option shares at the time of grant will be equal to the amount of
salary invested in that option. The option will vest and become exercisable in a
series of twelve equal monthly installments over the calendar year for which the
salary reduction is to be in effect and will be subject to full and immediate
vesting upon certain changes in the ownership or control.

        Automatic Option Grant Program -- Each individual who first becomes a
non-employee Board member at any time after the completion of this offering will
automatically receive an option grant for 25 shares on the date such individual
joins the Board, provided such individual has not been in the prior employ of
the Company. In addition, on the date of each annual shareholders meeting,
beginning with the 2001 annual shareholders meeting, each non-employee board
member who has served as a non-employee Board member since the date of the last
annual shareholders meeting will automatically be granted an option to purchase
8 shares of common stock.

        Each automatic grant will have a term of ten years, subject to earlier
termination following the optionee's cessation of Board service. The initial
25-shares option will be immediately exercisable for all of the option shares;
however, any unvested shares purchased under the option will be subject to
repurchase by us, at the exercise price paid per share, should the optionee
cease Board service prior to vesting in those shares. The shares subject to each
25 share automatic option grant will vest over a four-year period in successive
equal annual installments upon the individual's completion of each year of board
service over the four-year period measured from the option grant date. However,
the shares subject to each such automatic grant will immediately vest in full
upon certain changes in control or ownership of the Company or upon the
optionee's death or disability while a Board member. Each 8 share automatic
option grant will be immediately exercisable and fully vested on the option
grant date.

        Director Fee Option Grant Program -- If this program is put into effect,
each non-employee Board member may elect to apply all or a portion of any annual
retainer fee otherwise payable in cash to the acquisition of a below-market
option grant. The option grant will automatically be made on the first trading
day in January in the year for which the retainer fee would otherwise be payable
in cash. The option will have an exercise price per share equal to one-third of
the fair market value of the option shares on the grant date, and the number of
shares subject to the option will be determined by dividing the amount of the
retainer fee applied to the program by two-thirds of the fair market value per
share of common stock on the grant date. As a result, the option will be
structured so that the

                                      F-14
<PAGE>   45

fair market value of the option shares on the grant date less the aggregate
exercise price payable for those shares will be equal to the portion of the
retainer fee invested in that option. The option will become exercisable in a
series of twelve equal monthly installments over the calendar year for which the
election is to be in effect. However, the option will become immediately
exercisable for all the option shares upon certain changes in the ownership or
control or the death or disability of the optionee while serving as a Board
member.

        Limited Stock Appreciation Rights -- Limited stock appreciation rights
will automatically be included as part of each grant made under the automatic
option grant, salary investment option grant and director fee option grant
programs and may be granted to one or more of the Company's officers as part of
their option grants under the discretionary option grant program. Options with
such a limited stock appreciation right may be surrendered to the Company upon
the successful completion of a hostile tender offer for more than 50% of the
Company's outstanding voting stock. In return for the surrendered option, the
optionee will be entitled to a cash distribution from the Company in an amount
per surrendered option share based on the highest price per share of common
stock paid in connection with the tender offer.

        Amendment -- The board may amend or modify the 1999 Stock Incentive Plan
at any time, subject to any required shareholder approval. The 1999 Stock
Incentive Plan will terminate no later than June 8, 2009.

1999 EMPLOYEE STOCK PURCHASE PLAN

        Introduction -- The 1999 Employee Stock Purchase Plan was adopted by the
Board and approved by the shareholders in June 1999 and will become effective
immediately upon the effective date of the Company's initial public offering.
The 1999 Employee Stock Purchase Plan is designed to allow eligible employees
and the employees of participating subsidiaries to purchase shares of common
stock, at semi-annual intervals, through their periodic payroll deductions.

        Share Reserve -- At December 31, 1999, 600 shares of common stock were
reserved for issuance. In February, 2000, 119 shares of common stock were
purchased under the plan. At December 31, 1999, $1,269 was recorded in accrued
liabilities that employees had deposited for purchases of common stock under the
plan.

        Purchase Periods -- The plan has a series of successive purchase
periods, each with a maximum duration of six months. The initial purchase period
began on August 12, 1999 and ended on the last business day in January 2000.
Thereafter, purchase periods run from the first business day in February to the
last business day in July of each year, and from the first business day in
August to the last business day in January of the following year.

        Eligible Employees -- Individuals who are scheduled to work more than 20
hours per week for more than five calendar months per year on the start date of
any purchase period may join the plan on such start date.

        Payroll Deductions -- A participant may contribute up to 15% of their
cash earnings, and the accumulated payroll deductions will be applied to the
purchase of shares on each semi-annual purchase date. The purchase price per
share will be equal to 85% the fair market value of the common stock on the
start date of the purchase period or, if lower, the fair market value on the
semi-annual purchase date. Semi-annual purchase dates will occur on the last
business day of January and July each year. In no event, however, may any
participant purchase more than .6 shares on any semi-annual purchase date.

        Change in Control -- In the event the Company is acquired by merger or
asset sale, all outstanding purchase rights will automatically be exercised
immediately prior to the effective date of the acquisition. The purchase price
will be equal to 85% of the fair market value per share of common stock on the
participant's entry date into the offering period in which such acquisition
occurs or, if lower, the fair market value per share of common stock immediately
prior to such acquisition.

        Termination/Amendment -- The 1999 Employee Stock Purchase Plan will
terminate on the last business day of July 2009. The Board may at any time
alter, suspend or discontinue the plan. However, certain amendments to the plan
may require shareholder approval.

        As permitted by SFAS No. 123, Accounting for Stock-Based Compensation,
the Company has chosen to continue to account for its stock-based compensation
plans under APB Opinion No. 25 and provide the expanded disclosures specified in
SFAS No. 123.

                                      F-15
<PAGE>   46
        Compensation costs would not have significantly changed net income or
net income per share in fiscal 1997. Had compensation cost been determined using
the provisions of SFAS No. 123, the Company's net income available to common
shareholders would have been decreased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                      DECEMBER 31,    DECEMBER 31,
                                                         1998            1999
                                                       ---------      ---------
<S>                                                   <C>             <C>
Net income available to common shareholders:
  As reported ...................................      $   2,346      $   2,807
                                                       =========      =========
  Pro forma .....................................      $   2,177      $     202
                                                       =========      =========
Basic net income per share:
  As reported ...................................      $    0.05      $    0.07
                                                       =========      =========
  Pro forma .....................................      $    0.05      $    0.01
                                                       =========      =========
Diluted net income per share:
  As reported ...................................      $    0.05      $    0.07
                                                       =========      =========
  Pro forma .....................................      $    0.05      $    0.00
                                                       =========      =========
</TABLE>

        For purposes of estimating the compensation cost of the Company's option
grants in accordance with SFAS No. 123, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model,
with the following weighted average assumptions used for grants in the years
1997 and 1998, as a private company: expected volatility of zero; risk-free
interest rates of 6%; and expected lives of ten years. Weighted average
assumptions for 1999 were: expected volatility of 221%; risk-free interest rates
of 6%; and expected lives of five years.

        The following table summarizes activity under all of the Company's stock
option plans:

<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                 ---------------------------------------------------------------------
                                                         1997                    1998                    1999
                                                 --------------------     -------------------      -------------------
                                                             WEIGHTED                WEIGHTED                 WEIGHTED
                                                             AVERAGE                 AVERAGE                  AVERAGE
                                                             EXERCISE                EXERCISE                 EXERCISE
                                                 SHARES       PRICE       SHARES       PRICE       SHARES       PRICE
                                                 ------       -------     ------       ------      ------       ------
<S>                                              <C>         <C>          <C>        <C>           <C>        <C>
Outstanding, beginning of period ..........       1,531       $ 0.64         975       $ 0.77       3,367       $ 1.19
Granted ...................................          --       $   --       3,383       $ 1.19       2,391       $14.05
Exercised .................................          --       $   --          --       $   --         (34)      $ 1.00
Canceled ..................................        (556)      $ 0.40        (991)      $ 0.77        (468)      $ 3.20
                                                  -----                    -----                    -----       ------
Balance, end of period ....................         975       $ 0.77       3,367       $ 1.19       5,256       $ 6.87
Weighted average fair value of options
  granted during the year .................                       --                   $ 0.53                   $13.42
                                                              ======                   ======                   ======
</TABLE>

        The Company will record compensation expense of approximately $2,978
relating to options granted during the year ended December 31, 1999, to purchase
530 shares of common stock. The expense equals the difference between the fair
market value of the Company's common stock on the grant date and the exercise
price of the stock options and will be recognized ratably over the four-year
vesting period of the stock options. The Company recorded $432 of expense
associated with such option grants during the year ended December 31, 1999 which
is included in compensation and other costs in the accompanying consolidated
financial statements.

<TABLE>
<CAPTION>
                                                      DECEMBER 31, 1999
                           -------------------------------------------------------------------------
                                      OPTIONS OUTSTANDING                      OPTIONS EXERCISABLE
                           -----------------------------------------      --------------------------
                                            WEIGHTED
                                             AVERAGE        WEIGHTED                        WEIGHTED
                                            REMAINING       AVERAGE                         AVERAGE
         RANGE OF            NUMBER        CONTRACTUAL      EXERCISE        NUMBER          EXERCISE
     EXERCISE PRICES       OUTSTANDING        LIFE           PRICE        EXERCISABLE        PRICE
 ----------------------    -----------     -----------      --------      -----------       --------
<S>                        <C>             <C>              <C>           <C>               <C>
 $  1.00 -- 1.00 ......       2,161            8.49          $ 1.00             578          $ 1.00
 $  1.17 -- 3.77 ......       2,166            9.00          $ 2.33             125          $ 1.17
 $  6.00 -- 12.00 .....         473            9.53          $10.38              --              --
 $ 37.00 -- 45.00 .....         192            9.74          $41.03              --              --
 $ 50.75 -- 64.13 .....         198            9.90          $54.34              --              --
 $ 80.50 -- 80.50 .....          66            9.92          $80.50              --              --
                             ------                                          ------
                              5,256                                             703          $ 1.03
                             ======                                          ======          ======
</TABLE>

        Options to purchase 47 shares of common stock at exercise prices of
$1.00 to $1.17 per share were exercised in January 2000.

9. COMMITMENTS AND CONTINGENCIES

        The Company leases its office facilities and certain equipment under
various operating leases. The majority of these leases are non-cancelable and
obligate the Company to pay costs of maintenance, utilities, and applicable
taxes. The leases on most of the office


                                      F-16
<PAGE>   47

facilities contain escalation clauses and renewal options. Total rent expense
was $732, $1,038 and $2,593, for the years ended December 31, 1997, 1998, and
1999.

     Minimum lease commitments under noncancelable operating leases at December
31, 1999, are as follows:

<TABLE>
<CAPTION>
Year ending December 31:
<S>                                 <C>
2000 .........................      $ 3,457
2001 .........................        3,353
2002 .........................        3,245
2003 .........................        2,739
2004 .........................        2,656
Thereafter ...................        4,652
                                    -------
                                    $20,102
                                    =======
</TABLE>

        As a result of the acquisition of MBR (Note 2), the Company is obligated
under capital lease agreements for certain property and equipment requiring
monthly installments of principal and interest (at 10%) through 2004. The
present value of the remaining capital lease payments is $114 at December 31,
1999.

        The Company maintains a profit-sharing plan covering substantially all
employees. Quarterly contributions may be made by the Company based upon
employee salaries. Effective January 1, 1997, the Company amended and restated
the profit sharing plan to include a 401(k) plan. The Company contributed $134,
$466 and $929 to the amended plan for the years ended December 31, 1997, 1998
and 1999, respectively.

        On May 25, 1999, Mobius Management Systems, Inc., filed a complaint in
the United States District Court for the District of New Jersey (Mobius
Management Systems, Inc. v. Quest Software, Inc., Case No. 99-2337). The
complaint alleged that the Company published three advertisements that were
false and misleading and, therefore, in violation of the Lanham Act and common
law, and that the Company misappropriated unspecified trade secrets belonging to
Mobius. The advertisements that Mobius alleged in its complaint are false and
misleading were two e-mails intended for internal use, a comparison chart
believed to have been prepared by a former Company employee in 1997 for internal
purposes, and a statement made regarding the Company's Vista Plus Java client
which had been posted on the Internet. The case was settled in late 1999, with
both sides agreeing to pay their own legal fees. No other expenses were incurred
by the Company in connection with this matter.

        The Company is involved in various claims and legal actions arising in
the ordinary course of business. The litigation process is inherently uncertain,
and it is possible that the resolution of such claims and legal actions may
adversely affect the Company. However, it is the opinion of management that the
ultimate disposition of these matters will not materially affect the Company's
results of operations or financial position.

10. GEOGRAPHIC INFORMATION AND CONCENTRATION OF CREDIT RISK

        Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the Company's chief operating decision-maker, or decision-making group, in
deciding how to allocate resources and in assessing performance. The operating
segments of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.

        The Company's reportable operating segments include Licenses and
Services. The Software Licenses operating segment develops and markets the
Company's software products. The Services segment provides after-sale support
for software products and fee-based training and consulting services related to
the Company's products.

        The Company does not separately allocate operating expenses to these
segments, nor does it allocate specific assets to these segments. Therefore,
segment information reported includes only revenues, cost of sales and gross
profit, as this information and the geographic information described below are
the only information provided to the chief operating decision-maker.


                                      F-17
<PAGE>   48

        Operating segment data for the three years in the period ended December
31, 1999, was as follows:

<TABLE>
<CAPTION>
                                             LICENSES     SERVICES       TOTAL
                                              -------      -------      -------
<S>                                          <C>          <C>           <C>
Year ended December 31, 1997:
  Revenues .............................      $12,158      $ 6,157      $18,315
  Cost of revenues .....................        1,307        1,972        3,279
                                              -------      -------      -------
     Gross profit ......................      $10,851      $ 4,185      $15,036
                                              =======      =======      =======
Year ended December 31, 1998:
  Revenues .............................      $24,901      $ 9,889      $34,790
  Cost of revenues .....................        3,433        2,507        5,940
                                              -------      -------      -------
     Gross profit ......................      $21,468      $ 7,382      $28,850
                                              =======      =======      =======
Year ended December 31, 1999:
  Revenues .............................      $54,269      $16,599      $70,868
  Cost of revenues .....................        2,998        4,195        7,193
                                              -------      -------      -------
     Gross profit ......................      $51,271      $12,404      $63,675
                                              =======      =======      =======
</TABLE>

        Revenues are attributed to geographic areas based on the location of the
entity to which the products or services were sold. Revenues, gross profit,
income (loss) from operations and long-lived assets concerning principal
geographic areas in which the Company operates are as follows:

<TABLE>
<CAPTION>
                                               UNITED
                                               STATES    INTERNATIONAL   ELIMINATIONS      TOTAL
                                              --------      --------       --------       --------
<S>                                           <C>        <C>             <C>              <C>
Year ended December 31, 1997:
  Revenues .............................      $ 17,511      $  1,261       $   (457)      $ 18,315
  Gross profit .........................        14,413         1,075           (452)        15,036
  Income (loss) from operations ........         1,533          (339)           254          1,448
  Long-lived assets ....................         2,336           118             --          2,454

Year ended December 31, 1998:
  Revenues .............................      $ 32,189      $  4,172       $ (1,571)      $ 34,790
  Gross profit .........................        26,594         3,840         (1,584)        28,850
  Income (loss) from operations ........         3,839          (252)           102          3,689
  Long-lived assets ....................         1,600           315             --          1,915

Year ended December 31, 1999:
  Revenues .............................      $ 55,532      $ 19,736       $ (4,400)      $ 70,868
  Gross profit .........................        55,389         8,701           (415)        63,675
  Income from operations ...............         3,270           693            505          4,468
  Long-lived assets ....................        17,839         1,233             --         19,072
</TABLE>

        In fiscal 1997, 1998 and 1999, no single customer accounted for 10% or
more of total revenue. No single international location accounted for more than
5% of total revenues for any of the periods indicated.

11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)



<TABLE>
<CAPTION>
                                               FIRST       SECOND        THIRD       FOURTH       FISCAL
                                              QUARTER      QUARTER      QUARTER      QUARTER       YEAR
                                              -------      -------      -------      -------      -------
                                                    (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, 1999
<S>                                           <C>          <C>          <C>          <C>          <C>
  Revenue ..............................      $12,839      $15,450      $18,308      $24,271      $70,868
  Gross profit .........................       11,251       13,896       16,420       22,108       63,675
  Income before income taxes ...........        1,632          641          902        2,495        5,670
  Net income applicable to common
     shareholders ......................          943           31          272        1,561        2,807
  Basic earnings per share .............         0.02         0.00         0.01         0.04         0.07
  Diluted earnings per share ...........         0.02         0.00         0.01         0.04         0.07

YEAR ENDED DECEMBER 31, 1998
  Revenue ..............................      $ 7,043      $ 6,992      $ 8,734      $12,021      $34,790
  Gross profit .........................        5,965        5,522        7,044       10,319       28,850
  Income before income taxes ...........        1,483           53        1,073        1,416        4,025
  Net income applicable to common
     shareholders ......................          868           31          627          820        2,346
  Basic earnings per share .............         0.02         0.00         0.01         0.02         0.05
  Diluted earnings per share ...........         0.02         0.00         0.01         0.02         0.05
</TABLE>


                                      F-18
<PAGE>   49

12. SUBSEQUENT EVENTS

        On January 31 and February 11, 2000, the Company entered into two
non-binding letters of intent to acquire two companies for an aggregate purchase
price of $25 million.

        On March 9, 2000, the Company's Board of Directors approved a
two-for-one stock split of the Company's common stock which will be effective
March 31, 2000 for shareholders of record on March 20, 2000. The Company has
disclosed the pro forma effect of this split on basic and diluted net income per
share in the accompanying consolidated statements of operations. No other share,
per share or conversion amounts relating to common stock, preferred stock, and
stock options included in the accompanying consolidated financial statements and
footnotes have been restated to reflect the pending stock split.



                                      F-19
<PAGE>   50

                                   SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) 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.
                                       By:  /s/       DAVID M. DOYLE
                                          ------------------------------------
                                          David M. Doyle
                                          President and Secretary

        Pursuant to the requirements of the Securities Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
          SIGNATURE                                      TITLE                                DATE
          ---------                                      -----                                ----

<S>                                         <C>                                           <C>
/s/     VINCENT C. SMITH                         Chief Executive Officer                  March 30, 2000
-----------------------------------           (principal executive officer)
        Vincent C. Smith                        and Chairman of the Board


/s/     DAVID M. DOYLE                      President, Secretary and Director             March 30, 2000
-----------------------------------
        David M. Doyle


/s/     JOHN J. LASKEY                           Chief Financial Officer                  March 30, 2000
-----------------------------------             (principal financial and
        John J. Laskey                        accounting officer) and Vice
                                                   President, Finance


/s/     DORAN G. MACHIN                                 Director                          March 30, 2000
-----------------------------------
        Doran G. Machin


/s/     JERRY MURDOCK, JR.                              Director                          March 30, 2000
-----------------------------------
        Jerry Murdock, Jr.
</TABLE>
<PAGE>   51

                                 EXHIBIT INDEX
<TABLE>
     EXHIBIT
     NUMBER                        EXHIBIT TITLE
     ------                        -------------
<S>               <C>
     3.1 **       Second Amended and Restated Articles of Incorporation.

     3.2 *****    Second Amended and Restated Bylaws, as amended.

     4.1 **       Form of Registrant's Specimen Common Stock Certificate.

    10.1 **++     Registrant's 1998 Stock Option/Stock Issuance Plan.

    10.2 **++     Registrant's 1999 Stock Incentive Plan.

    10.3 **++     Registrant's 1999 Employee Stock Purchase Plan.

    10.4 **       Form of Directors' and Officers' Indemnification Agreement.

    10.5 **       Securities Purchase Agreement, dated as of April 21, 1999,
                  by and among Quest Software, Inc. and InSight Capital Partners
                  II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS
                  Capital LLC, and WI Software Investors LLC.

    10.6**        Investors' Rights Agreement dated as of April 21, 1999
                  among Quest Software, Inc. and InSight Capital Partners II,
                  L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital
                  LLC, and WI Software Investors LLC.

    10.7+**       Agreement, dated February 19, 1999, between Quest
                  Software, Inc. and INSO Chicago Corporation, dba INSO
                  Corporation.

    10.8+**       OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc.

    10.9 **       Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest
                  Software, Inc.

    10.10*****    Office Lease between The Northwestern Mutual Life
                  Insurance Company (Landlord) and Quest Software, Inc. (Tenant)
                  dated as of September 30, 1999.

    10.11+*****   Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight
                  Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software,
                  Inc.

    10.12***      Agreement and Plan of Merger dated as of November 2, 1999,
                  as amended, by and among Quest, Quest Merger Corporation, MBR
                  Technologies, Inc., and certain shareholders of MBR
                  Technologies, Inc.

    10.13****     Agreement and Plan of Merger dated as of November 10,
                  1999, by and among Quest, Quest Acquisition Corporation II,
                  Inc., and Foglight Software, Inc.

    23.1          Consent of Deloitte & Touche LLP.

    27.1          Financial Data Schedule (In electronic format only).
</TABLE>

----------

**     Incorporated by reference herein to the Company's Registration Statement
       on Form S-1 and all amendments thereto (File No. 333-80543).

***    Incorporated by reference herein to the Form 8-K and all amendments
       thereto filed with the Securities and Exchange Commission on December 29,
       1999.

****   Incorporated by reference herein to the Form 8-K and all amendments
       thereto filed with the Securities and Exchange Commission on January 21,
       2000.

*****  Incorporated by reference herein to the Company's Registration Statement
       on Form S-1 and all amendments thereto (File No. 333-30816).

+      Confidential treatment requested and received as to certain portions of
       this agreement.

++     Indicates a management contract or compensatory arrangement.