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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K

(Mark One)

|       |  |                                                                                     
|------ |  | ------------------------------------------------------------------------------------
|(xbox) |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2001

OR

|      |  |                                                                                         
|----- |  | ----------------------------------------------------------------------------------------
|(box) |  | 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
(State or Other Jurisdiction of
Incorporation or Organization)            |  | 33-0231678
(I.R.S. Employer
Identification No.)
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                     |  |                                                
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|8001 Irvine Center Drive
Irvine, California
(Address of Principal Executive Offices) |  | 92618
(Zip Code)                               

Registrants Telephone Number, Including Area Code:  (949) 754-8000

Securities Registered Pursuant to Section 12(b) of the Act:   None

Securities Registered Pursuant to Section 12(g) of the Act:  Common Stock

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  (xbox)   No  (box)

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.   (xbox)

As of March 13, 2002, 89,735,502 shares of the Registrants Common Stock
were outstanding. The aggregate market value of the common stock held by
nonaffiliates of the Registrant as of March 13, 2002 was approximately $737.4 million.

Documents Incorporated by Reference

Portions of the Registrants definitive proxy statement, to be delivered
to shareholders in connection with the Registrants 2002 Annual Meeting of
Shareholders, are incorporated by reference into Part III of this Report.



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TABLE OF CONTENTS



|                                                |                                                                                               |  |  |  |  |  |  | 
|----------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                         
|                                                | Item 1. Business                                                                             
|                                                | Item 2. Properties                                                                           
|                                                | Item 3. Legal Proceedings                                                                    
|                                                | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                        
|                                                | Item 5. Market for the Registrants Common Equity and Related Shareholder Matters            
|                                                | Item 6. Selected Financial Data                                                              
|                                                | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                | Item 7a. Quantitative and Qualitative Disclosures About Market Risks                         
|                                                | Item 8. Financial Statements and Supplementary Data                                          
|                                                | Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
|PART III                                       
|                                                | Item 10. Directors and Executive Officers of the Registrant                                  
|                                                | Item 11. Executive Compensation                                                              
|                                                | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                                                | Item 13. Certain Relationships and Related Transactions                                      
|PART IV                                        
|                                                | Item 14. Exhibits, Financial Statement Schedules And Reports On Form 8-K                     
|SIGNATURES                                     
|INDEPENDENT AUDITORS REPORT                   
|CONSOLIDATED BALANCE SHEETS                    
|CONSOLIDATED STATEMENTS OF OPERATIONS          
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
|CONSOLIDATED STATEMENTS OF CASH FLOWS          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|EXHIBIT 21.1                                   
|EXHIBIT 23.1                                   



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TABLE OF CONTENTS

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|                             |  | PART I                                                                                |  |  |    |     
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|Item 1.                      |  | Business                                                                              |  |  | 1  |     
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|Item 2.                      |  | Properties                                                                            |  |  | 8  |     
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|Item 3.                      |  | Legal Proceedings                                                                     |  |  | 8  |     
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|Item 4.                      |  | Submission of Matters to a Vote of Security Holders                                   |  |  | 8  |     
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|                             |  | PART II                                                                               |  |  |    |     
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|Item 5.                      |  | Market for the Registrant's Common Equity and Related Shareholder Matters             |  |  | 8  |     
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|Item 6.                      |  | Selected Financial Data                                                               |  |  | 10 |     
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|Item 7.                      |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  |  | 11 |     
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|Item 7a.                     |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |  | 25 |     
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|Item 8.                      |  | Financial Statements and Supplementary Data                                           |  |  | 26 |     
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|Item 9.                      |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosures |  |  | 26 |     
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|                             |  | PART III                                                                              |  |  |    |     
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|Item 10.                     |  | Directors and Executive Officers of the Registrant                                    |  |  | 27 |     
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|Item 11.                     |  | Executive Compensation                                                                |  |  | 27 |     
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|Item 12.                     |  | Security Ownership of Certain Beneficial Owners and Management                        |  |  | 27 |     
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|Item 13.                     |  | Certain Relationships and Related Transactions                                        |  |  | 27 |     
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|                             |  | PART IV                                                                               |  |  |    |     
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|Item 14.                     |  | Exhibits, Financial Statement Schedule, and Reports on Form 8-K                       |  |  | 27 |     
|                            
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|SIGNATURES                   |  | 29                                                                                    | 
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|FINANCIAL STATEMENTS         |  | F-1                                                                                   | 
|                            
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|FINANCIAL STATEMENT SCHEDULE |  |                                                                                       | 

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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. 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. 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
suggested by forward looking information.




PART I




Item 1.  Business

Overview

Quest Software is a leading developer and vendor of application and
database management software products. We also provide support and maintenance
services for our products as well as post-sale consulting services. Our
products improve, in many cases dramatically, the quality of service provided
by our customers key software applications. Many of our products also
significantly reduce our customers capital and operating expenses associated
with these systems by minimizing hardware, software and/or personnel costs.

Over the last ten years, large and medium-sized enterprises have widely
implemented packaged applications for financial reporting, enterprise resource
planning (ERP), supply chain management, human resources, customer
relationship management (CRM), e-mail and other critical functions. Quests
application management products support the packaged applications
from many of
the leading vendors  SAP, Siebel, PeopleSoft and Oracle. Many enterprises also
continue to run and deploy internally developed applications. Both packaged and
internally developed applications require a database system such as Oracle,
Microsoft SQL Server or IBMs DB2 to store, access and organize the
applications data. Our products support all three leading
databases. These database systems are
in many cases the most complex components of the application infrastructure
and, as the sole repositories of irreplaceable enterprise data, the most
important.

In addition to products for application and database management, we
provide products for management of the Microsoft Windows operating environment. In
furtherance of these efforts, we acquired Fastlane Technologies, Inc.
in September 2000. Fastlane's solutions include products for
migration to and management of Windows 2000 with a focus on
its Active Directory distributed management system.

Our strategy is to target high value, widely adopted software platforms
and to build world-class development expertise for those domains. This approach
has enabled Quest to establish market leadership as a provider of products and
solutions for Oracle databases. We invest heavily in our product engineering
capabilities, which we believe provides competitive differentiation and is a
key to long-term success. In building our products, we stress ease of
deployment, ease of use and tangible, readily articulated customer benefits.
We sell our products primarily via our direct sales channel, supplemented by
indirect sales through systems integrators and value added resellers. We
operate principally in North and South America, Europe and Australia.

Quest
is a California corporation incorporated in 1987. Our principal
offices are located at 8001 Irvine Center Drive, Irvine, California
92618.

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The Need for Application Management
Solutions

Application downtime or performance degradation can halt or greatly impede
an enterprises daily operations. In most cases, these problems are
attributable to software components. Our focus is on the
operation and performance of applications and their underlying components in
high stress deployments. Our product strategy is to provide best in class
enterprise management solutions designed to ensure the availability,
performance and recoverability of critical application services with rapid
deployment of the management solution.

An application is useless if it is not available to end-users. This
criticality becomes increasingly acute as networked computing, fueled by the
Internet, proliferates. Customers and employees require and expect full time
access to a companys IT systems. Since the emergence of e-business has allowed
consumers to directly communicate with an organizations
internal systems, it is more
important than ever before to maximize application performance and minimize
downtime. Furthermore, as e-business, ERP, CRM 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. 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 to ensure the distribution
of information throughout the enterprise. However, the requirements of todays
IT systems have stretched the capabilities of these traditional solutions.

While internet-based internal and external applications remain important,
enterprises are re-focusing their IT projects back to improving the service
levels and reliability of their existing core systems. For business critical
databases and applications, many of our products are relevant to these efforts.
In many cases, our products increase the cost effectiveness of existing
investments in software, computer hardware, storage systems and/or IT
personnel. Our application performance management solutions such as the
Foglight and Spotlight products discussed below enable IT organizations to
monitor and manage the application service levels they provide to internal and
external end-users.

Enterprises must also contend with the demands of ever increasing data.
One recent survey projects that the amount of information stored electronically
will double in the next three years. Much of
this data is stored in database management systems such as Oracle, DB2 and
Microsoft SQL server. These trends create demand for our database tools that
can improve the utilization and reliability of large-scale databases and of the developers and
database administrators and other personnel responsible for
application reliability
and performance.

The Quest Solutions

One of the most significant benefits afforded by Quest solutions derives
from their ease of use and implementation. Software that is difficult to
implement or use often does not deliver the value promised. A primary design
goal for Quest products is to provide a quick return on investment. We believe
our products can, in many cases, allow for more efficient and productive use of
employee and IT resources.



|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | Important characteristics of our products include:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Maximization of Customers
Investments 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.

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|Ease of Deployment and Use.Our products are easy to deploy and use,
thereby minimizing implementation, training and support costs. We attempt
to design 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.                                                                                                                          
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Scalability.Our products are well-suited for large, enterprise-wide
deployments. We attempt to design our products to effectively scale when
implemented in large and rapidly expanding environments without
compromising system performance. Our products
support heterogeneous networks, manage large quantities of information
and
support thousands of users while at the same time minimizing the
consumption of
network and computing resources. Our Java user interfaces significantly
reduce
the need for client-side software management, effectively leveraging
todays
wide deployment of Internet browser technology.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Exploitation of Web
Technologies.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; often employ HTML or Java-based interfaces to deliver
Web access to business information; and ensure the security
and
integrity of Web-based access to applications.                                                                               

Application
Availability Products

We offer products and solutions that enhance the reliability and
performance of software applications by addressing known operational problems
in the applications, databases, operating systems and other layers of the
application stack. Types of benefits our products provide include:



| |  |  | Real-time replicating and reorganizing of Oracle databases.
Real-time replication is required by customers who need to create and
keep current a secondary copy of their transactional Oracle database for
back-up and recovery purposes or to offload management information
querying and reporting. Real-time reorganization allows a customer to
perform required database reorganizations without incurring the system
downtime that is otherwise necessary, resulting in improved
performance and reduced storage utilization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Monitoring and managing the availability and performance of
databases and packaged applications including SAP, Oracle E-Business
Suite,
Siebel and Peoplesoft. Quest offers comprehensive tools for detecting,
diagnosing and resolving database performance issues and bottlenecks in
real-time. Quest offers Quest Central and other database management
tools that automate many tedious, error prone and costly administrative
tasks in production Oracle and DB2 environments. For service level
management, our Foglight enterprise monitor tracks many performance
characteristics of a SAP, Siebel, Oracle or Peoplesoft application and the
databases and operating systems on which they run. Foglight will alert
appropriate IT personnel of existing or threatened nonconforming
operating conditions so that they can take preventative or corrective
actions. Our series of complementary Spotlight diagnostic products allow IT
personnel to drill down deeply into the many components of an
application, database or other layer of the application stack to identify
the root causes of a problem.

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| |  | Enabling developers of applications running on Oracle databases to
develop, test and deploy these applications much more productively and
with much higher quality. Any major application running on an Oracle
database, including pre-packaged applications, requires substantial
customization both for initial deployment and ongoing iterative
improvements to the system. Using the Quest PL/SQL development
environments for Oracle, application and database developers can design and develop
queries, test and analyze their impact on a production system, deploy the
new code and manage changes to the application and database over time.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Windows 2000 and Active
Directory form a cornerstone of Microsoft's strategic direction.
While the benefits of utilizing these technologies are extensive, the
process of migrating to and managing Active Directory is highly
complex. Our Fastlane products are designed to simplify the
transition to Windows 2000 and allow system administrators to
effectively and efficiently manage their network of Windows systems.                                                                                                                                                                                                                         

Information Availability Products

Our
Vista Plus Information Availability products enable enterprises
to deliver information internally and externally via the Internet to reach
employees, customers and partners throughout large and geographically dispersed
organizations. The capabilities of these products include:



| |  | Providing Internet access to enterprise information by a greater number
of users, without any changes to existing or new applications;                 
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Minimizing delays in publishing information;                                                                                                           
| 
| |  | Reducing manual printing and delivery costs associated with paper-based
report distribution; and                                                       
| 
| |  | Optimizing the storage and distribution of information by publishing
information a single time from disparate applications to a centralized repository.

Sales, Marketing and Distribution

We market and sell our products and services worldwide primarily through
our direct sales organization. At December 31, 2001, we had 351 direct sales
representatives. We employ a field sales force that is deployed in major
metropolitan areas and is organized into account teams consisting of a
designated account manager and dedicated sales specialists for certain product
lines. We also have a large telesales organization that concentrates on lower
price point products such as our Oracle development tools. We supplement our
direct sales organization with indirect sales channels such as resellers, value
added resellers, and systems integrators. We also employ local resellers in
certain international territories not covered by our local sales offices.

We have opened sales offices in the major cities of the United States and
Europe to facilitate close contact between current and potential customers and
our field sales organization, which includes sales teams as well as pre- and
post- sales technical consultants. At December 31, 2001, we had
44 sales
offices including our headquarters offices in Irvine, California.

Our sales and marketing approach is designed to help customers understand
both the business and technical benefits of our products. Much of our sales
activity involves free product trials for a limited period, typically 30 days,
during which a customer can experience the benefits of our products. Pre-sales
technical consultants assist our sales teams by conducting on-site proofs of
concept and providing other in-depth technical services. We facilitate trial
use of our products by making trial copies easily available on our website.
Finally, we allow sales prospects full access to our customer support
organization so that they can obtain an accurate view of the Quest customer
experience. We believe this practice contributes in many cases to the purchase
of our products.

Our marketing efforts are designed to create awareness for our products
and generate sales leads. To achieve these goals, we promote our technical
leadership, participate in industry trade shows, technical conferences and
technology seminars, publish technical and educational articles in industry
journals and engage in a variety of other marketing activities, including direct mailings and print and
Web-based advertising.

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Our professional services organization complements our direct sales
organization by providing customers with a full range of support services,
including implementations, consulting services and training. We believe that
professional services are important to customer satisfaction and the
development of customer relationships.

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. We have a reputation for providing the highest level of customer
support and believe this is a competitive differentiator. Enrollment in our
support, maintenance and enhancement program is annual and entitles a customer
to problem resolution services and to receive new versions of a product that
include functional enhancements and forward compatibility with the database,
application or other platform supported by the product. Annual maintenance,
support and enhancement fees generally range from 20% to 25% of the initial
purchase cost, depending on the product and the level of problem resolution
support purchased. Customer support is provided domestically through our
offices in Irvine and internationally through our offices in Europe and Canada.

Research and Development

We believe that strong research and product development capabilities are
essential to enhancing our core technologies and developing additional products
that combine ease of use and enhance return on IT infrastructure investments.
Highly innovative product design and strong product engineering are Quest
hallmarks. We target ease of implementation and ease of use in designing our
products. Our commitment to ongoing product development is reflected in our
level of investment in research and development, which we believe is at the
high end of the range for our peer companies. Research and development
expenditures were $16.0 million, $39.7 million and $59.5 million for the years
ended December
31, 1999, 2000 and 2001, respectively. We have actively recruited key software
engineers and developers with expertise in the areas of Oracle technologies,
Java, Microsoft development technologies, ERP and CRM systems, IBM database
technologies and document management. Our engineers include several of the
industrys leading database management authorities. Complementing these
individuals, our senior management has extensive background in applications and
database management and monitoring and enterprise and system software
industries.

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 value proposition of our products in terms of return on investment
and/or reduced cost of ownership;                   
|
| |  |  | 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.                                                                      

We compete in some cases with the vendors of databases, applications and
other systems that we manage; for example, Oracle provides various tools for
managing its databases that are competitive with Quest offerings. In some cases
these platform

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vendor-provided tools are bundled with the platform and in other cases
they are separately chargeable products, albeit at significantly lower price
points. The inclusion of the functionality of our software as standard features
of the underlying database solution or application supported by our products or
sale at much lower cost could erode our revenues, particularly if the competing
products and features were of comparable capability to our products. Even if
the functionality provided as standard features or lower costs 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 our products. Moreover, there is substantial risk that
the mere announcements of competing products or features 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 or
features.

We also compete with other vendors of database, application and systems
management tools. Public companies with whom we compete include:



| |  |  | the large, well established systems management vendors -
IBM/Tivoli, Computer Associates and BMC Software;
| | - |  | ----------------------------------------------------------------------------------------------------------
|
| |  |  | smaller application and database management vendors such as Mercury
Interactive, Embarcadero and Precise; 
|
| |  |  | providers of Windows NT management and migration tools, such as NetIQ
and BindView.                       

Some 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.
Competitors may also 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.

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. Venture
capitalists and others have funded numerous application, database and systems
management companies over the last five years. Accordingly, it is likely that
new competitors or alliances among current and new competitors will emerge and
rapidly gain acceptance.

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 depend 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 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. We currently hold several trademark registrations
and have numerous trademark applications in the United
States and certain foreign countries.

6



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Employees

As of December 31, 2001, we employed 1,642 full-time employees, including
694 in sales and marketing, 597 in research and development, 109 in customer
service and support and 185 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.

Executive Officers of the Registrant

The names of our executive officers and other information about them are
shown below.

|                  |  |     |    |          |  |                                                  
|----------------- |  | --- | -- | -------- |  | -------------------------------------------------
|Name              |  | Age |    | Position
|                  |  |     |    |         
|Vincent C. Smith  |  |     | 38 |          |  | Chief Executive Officer and Chairman of the Board
|                 
|                 
|                 
|                 
|David M. Doyle    |  |     | 41 |          |  | President, Secretary and Director                
|                 
|                 
|                 
|                 
|M. Brinkley Morse |  |     | 44 |          |  | Vice President, Finance and Operations           
|                 
|                 
|                 
|                 
|Eyal M. Aronoff   |  |     | 38 |          |  | Chief Technical Officer, DB Tools                
|                 
|                 
|                 
|                 
|John R. Newsom    |  |     | 40 |          |  | Vice President Sales, Americas                   
|                 
|                 
|                 
|                 
|Anthony Foley     |  |     | 42 |          |  | Vice President Sales, EMEA                       

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.

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.

M. Brinkley Morse is our Vice President, Finance and Operations. Mr. Morse
has held this position since January 2001. Before joining Quest, Mr. Morse
served as Senior Vice President, Corporate Development and Secretary of BMC
Software from September 1998 to August 2000, and he served as General Counsel
and Secretary of BMC from November 1988 to September 1998.

Eyal M. Aronoff is our Chief Technical Officer and has held
this
position since September 2000. From March 1996 to September 2000, Mr. Aronoff
was our Vice President of Technology and Engineering. Mr. Aronoff founded
R*Tech
Systems, a database management company, in 1992 and served as its President
from
1992 to 1996, when we acquired this company. Prior to this, Mr. Aronoff worked
for John Bryce Ltd., an Oracle distributor in Israel, and served in the Israeli
Defense Force.

7



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##### Table of Contents



John
R. Newsom is our Vice President of Sales, Americas.
Mr. Newsom has served Quest in a variety of sales and sales
management positions for more than five years, including positions as
a regional sales director from 1999 through 2000, a regional vice
president in 2001 and his current position since January 2002. Before
joining Quest in July 1996, Mr. Newsom served in software
program management functions at Tandem Computers.

Anthony
Foley is our Vice President of Sales, EMEA, and has held this
position since April 2000. From February 1997 until he joined Quest,
Mr. Foley served in senior sales and operations management
positions for the European operations of Computer Associates
International, Inc. Prior to his employment with CA, Mr. Foley
served in business development positions for European subsidiaries of
GE Capital and IBM.




Item 2.Properties

Our principal administrative, sales, marketing, support and research and
development facilities are currently located in approximately 132,500 square
feet of space in Irvine, California. One of these facilities is under a
six-year
lease which includes an option to renew this lease for an additional five-year
term. The other facility is under a 3 1/2 year lease.

We also lease sales offices in several major metropolitan areas of the
U.S., including Atlanta, Boston, Chicago, Dallas, Houston, New York, San
Francisco and Washington, D.C. Our Canadian subsidiaries currently operate from
three leased
facilities in Calgary, Alberta; Ottawa, Ontario and Halifax, Nova Scotia. Our
German subsidiary currently operates from a leased facility in Cologne. Our
Australian subsidiary operates from two leased facilities in Melbourne and
Sydney, 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 involved from time to time in a variety of legal and administrative
proceedings and claims which arise in the ordinary course of business. While
the
outcome of these claims can not be predicted with certainty, we do not believe
that the outcome of any currently pending legal matters will have a material
adverse effect on Quest.




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 2001.




PART II




Item 5.Market for the 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 sale prices on the Nasdaq National Market for our common stock for the
periods indicated. All prices are adjusted to reflect our two-for-one stock
split effected in March 2000.

|      |                |  |                 |       |     |  |   |       | 
|----- | -------------- |  | --------------- | ----- | --- |  | - | ----- | 
|      |                |  | PRICE RANGE    
|      |                |  | OF COMMON STOCK
|      |                |  |                
|      |                |  | HIGH            |       | LOW
|      |                |  |                 |       |    
|2000: |                |  |                 |       |     |  |   |      
|     
|     
|     
|     
|      | First Quarter  |  | $               | 98.13 |     |  | $ | 36.50 | 
|     
|     
|     
|     
|      | Second Quarter |  |                 | 60.63 |     |  |   | 23.63 | 
|     
|     
|     
|     
|      | Third Quarter  |  |                 | 69.56 |     |  |   | 43.50 | 
|     
|     
|     
|     
|      | Fourth Quarter |  |                 | 64.38 |     |  |   | 25.63 | 
|     
|     
|     
|     
|2001: |                |  |                 |       |     |  |   |      
|     
|     
|     
|     
|      | First Quarter  |  | $               | 40.00 |     |  | $ | 14.81 | 
|     
|     
|     
|     
|      | Second Quarter |  |                 | 38.13 |     |  |   | 14.63 | 
|     
|     
|     
|     
|      | Third Quarter  |  |                 | 37.50 |     |  |   | 9.70  | 
|     
|     
|     
|     
|      | Fourth Quarter |  |                 | 27.20 |     |  |   | 10.32 | 

On March 13, 2002, the closing price of our common stock on the Nasdaq
National Market was $20.01 per share. As of March 13, 2002, there were 286
holders of record of our common stock (not including beneficial holders of
shares held in street name).

8



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##### Table of Contents



We have not declared or paid any cash dividends on our common stock in the
last two fiscal years and do not expect to do so in the foreseeable future. We
currently intend to retain all available funds for use in the operation and
expansion of our business. Any future determination to pay dividends will be at
the discretion of our board of directors and will depend on our results of
operations, financial conditions, contractual and legal restrictions and other
factors the board deems relevant.

Equity Compensation Plan Information

The following table gives information about our Common Stock that may be
issued upon the exercise of options under all of our existing equity
compensation plans as of December 31, 2001, including our 1999 and 2001 Stock
Incentive Plans, and stock
options assumed in connection with our acquisitions of Foglight
Software, OnWire Technologies and FastLane Technologies.

|                                                           |  |                                      |            |                  |  |                         |       |                         |  |                      |           | 
|---------------------------------------------------------- |  | ------------------------------------ | ---------- | ---------------- |  | ----------------------- | ----- | ----------------------- |  | -------------------- | --------- | 
|                                                           |  | Equity Compensation Plan Information
|                                                           |  |                                     
|                                                           |  |                                      |            |                  |  |                         |       |                         |  | Number of securities
|                                                           |  | Number of                            |            |                  |  |                         |       | remaining available for
|                                                           |  | securities to be                     |            | Weighted         |  | future issuance under  
|                                                           |  | issued upon                          |            | average exercise |  | equity compensation    
|                                                           |  | exercise of                          |            | price of         |  | plans (excluding       
|                                                           |  | outstanding                          |            | outstanding      |  | securities reflected in
|Plan Category                                              |  | options (a)                          |            | options (b)      |  | column (a)) (c)        
|                                                           |  |                                      |            |                  |  |                        
|Equity compensation plans
approved by security holders     |  |                                      | 11,200,094 |                  |  | $                       | 13.59 |                         |  |                      | 2,339,437 | 
|                                                          
|                                                          
|                                                          
|                                                          
|Equity compensation plans not
approved by security holders |  |                                      | 4,368,800  | (1)              |  | $                       | 13.65 |                         |  |                      | 631,200   | 
|                                                           |  |                                      |            |                  |  |                         |       |                         |  |                      |           | 
|Totals                                                     |  |                                      | 15,568,894 |                  |  | $                       | 13.61 |                         |  |                      | 2,970,637 | 
|                                                           |  |                                      |            |                  |  |                         |       |                         |  |                      |           | 



|(1) |  | Issued under our 2001 Stock Incentive Plan, which does not require the approval of and has
not been approved by our stockholders. See the description below of the 2001 Stock Incentive Plan.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

2001 Stock Incentive Plan

As of December 31, 2001, we had reserved 5.0 million shares of Common
Stock for issuance under the 2001 Stock Incentive Plan (the 2001 Plan) for
employees. The 2001 Plan provides for the granting of non-qualified stock
options to employees at the fair market value of our Common Stock at the grant
date. Officers and directors of Quest are not eligible to participate in the
2001 Plan unless and until the 2001 Plan is approved by our shareholders.
Options granted under the 2001 Plan have ten-year terms and generally vest 20%
after the first year and in 10% increments every six months thereafter. The
2001 Plan is not required to be and has not been approved by the Companys
shareholders.

9



---



##### Table of Contents






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,
1999, 2000 and 2001, and the consolidated balance sheet data at December 31,
2000 and 2001, have been derived from audited consolidated financial statements
included elsewhere in this Report. The consolidated data presented below for
the years ended December 31, 1997 and 1998, and at December 31, 1997, 1998 and 1999, are derived from
audited consolidated financial statements that are not included in this Report.

|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |         |         | 
|-------------------------------------------- | ------------------------------------------------------ | ------------------------ | ------ | ------ | ------ | ---- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|(In thousands,
except per share data)        |                                                        | Year Ended December 31, 
|                                             |                                                        |                         
|                                             |                                                        |                          |        | 1997   |        | 1998 |        | 1999   |        | 2000 |        | 2001  
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |       
|Consolidated Statement of Income Data:       |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                            
|                                            
|                                            
|                                            
|Revenues:                                    |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                            
|                                            
|                                            
|                                            
|                                             | Licenses                                               |                          | $      | 12,158 |        |      | $      | 24,901 |        |      | $      | 54,269 |        |   | $       | 126,767 |         |   | $       | 174,134 |        
|                                            
|                                            
|                                            
|                                            
|                                             | Services                                               |                          |        | 6,157  |        |      |        | 9,889  |        |      |        | 16,599 |        |   |         | 38,820  |         |   |         | 71,216  |        
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                             |                                                        | Total revenues           |        |        | 18,315 |      |        |        | 34,790 |      |        |        | 70,868 |   |         |         | 165,587 |   |         |         | 245,350 | 
|                                            
|                                            
|                                            
|                                            
|Cost of revenues:                            |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                            
|                                            
|                                            
|                                            
|                                             | Licenses                                               |                          |        | 1,307  |        |      |        | 3,433  |        |      |        | 2,998  |        |   |         | 3,571   |         |   |         | 4,510   |        
|                                            
|                                            
|                                            
|                                            
|                                             | Services                                               |                          |        | 1,972  |        |      |        | 2,507  |        |      |        | 4,195  |        |   |         | 10,695  |         |   |         | 17,369  |        
|                                            
|                                            
|                                            
|                                            
|                                             | Amortization
of purchased intangible assets            |                          |        |       |        |      |        |       |        |      |        |        |        |   |         | 5,038   |         |   |         | 8,003   |        
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                             |                                                        | Total cost of revenues   |        |        | 3,279  |      |        |        | 5,940  |      |        |        | 7,193  |   |         |         | 19,304  |   |         |         | 29,882  | 
|                                            
|                                            
|                                            
|                                            
|Gross profit                                 |                                                        |                          | 15,036 |        |        |      | 28,850 |        |        |      | 63,675 |        |        |   | 146,283 |         |         |   | 215,468 |        
|                                            
|                                            
|                                            
|                                            
|Operating expenses:                          |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                            
|                                            
|                                            
|                                            
|                                             | Sales and marketing                                    |                          |        | 5,845  |        |      |        | 11,836 |        |      |        | 32,078 |        |   |         | 77,641  |         |   |         | 121,901 |        
|                                            
|                                            
|                                            
|                                            
|                                             | Research and development                               |                          |        | 4,293  |        |      |        | 8,047  |        |      |        | 15,980 |        |   |         | 39,747  |         |   |         | 59,548  |        
|                                            
|                                            
|                                            
|                                            
|                                             | General and administrative                             |                          |        | 3,450  |        |      |        | 5,278  |        |      |        | 9,906  |        |   |         | 17,679  |         |   |         | 23,993  |        
|                                            
|                                            
|                                            
|                                            
|                                             | Other
compensation costs and goodwill amortization (1) |                          |        |       |        |      |        |       |        |      |        | 1,243  |        |   |         | 41,092  |         |   |         | 63,727  |        
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                             |                                                        | Total operating expenses |        |        | 13,588 |      |        |        | 25,161 |      |        |        | 59,207 |   |         |         | 176,159 |   |         |         | 269,169 | 
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|Income (loss) from operations                |                                                        |                          | 1,448  |        |        |      | 3,689  |        |        |      | 4,468  |        |        |   | (29,876 | )       |         |   | (53,701 | )      
|                                            
|                                            
|                                            
|                                            
|Other income (expense), net                  |                                                        |                          | (137   | )      |        |      | 336    |        |        |      | 1,202  |        |        |   | 11,603  |         |         |   | 8,208   |        
|                                            
|                                            
|                                            
|                                            
|Losses on equity investments                 |                                                        |                          |       |        |        |      |       |        |        |      |       |        |        |   |        |         |         |   | (4,405  | )      
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|Income (loss) before income tax provision    |                                                        |                          | 1,311  |        |        |      | 4,025  |        |        |      | 5,670  |        |        |   | (18,273 | )       |         |   | (49,898 | )      
|                                            
|                                            
|                                            
|                                            
|Income tax provision                         |                                                        |                          | 1,022  |        |        |      | 1,679  |        |        |      | 2,273  |        |        |   | 6,805   |         |         |   | 5,861   |        
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|Net income (loss)                            |                                                        | $                        | 289    |        |        | $    | 2,346  |        |        |      | 3,397  |        |        | $ | (25,078 | )       |         | $ | (55,759 | )      
|Preferred stock dividends (2)                |                                                        |                          |       |        |        |      |       |        |        |      | 590    |        |        |   |        |         |         |   |        |        
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|Net income applicable to common shareholders |                                                        | $                        | 289    |        |        | $    | 2,346  |        |        | $    | 2,807  |        |        | $ | (25,078 | )       |         | $ | (55,759 | )      
|                                             |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|Basic net income (loss) per share            |                                                        | $                        | 0.00   |        |        | $    | 0.03   |        |        | $    | 0.04   |        |        | $ | (0.29   | )       |         | $ | (0.63   | )      
|                                            
|                                            
|                                            
|                                            
|Diluted net income (loss) per share          |                                                        | $                        | 0.00   |        |        | $    | 0.03   |        |        | $    | 0.03   |        |        | $ | (0.29   | )       |         | $ | (0.63   | )      
|                                            
|                                            
|                                            
|                                            
|Weighted average shares outstanding:         |                                                        |                          |        |        |        |      |        |        |        |      |        |        |        |   |         |         |         |   |         |        
|                                            
|                                            
|                                            
|                                            
|                                             | Basic                                                  |                          |        | 80,746 |        |      |        | 88,522 |        |      |        | 75,354 |        |   |         | 85,332  |         |   |         | 87,971  |        
|                                            
|                                            
|                                            
|                                            
|                                             | Diluted                                                |                          |        | 81,234 |        |      |        | 88,918 |        |      |        | 83,600 |        |   |         | 85,332  |         |   |         | 87,971  |        



---

|(1) |  | Other compensation costs and
goodwill amortization includes amortization of $35.9 million in 2000 and $56.7 million in
2001 of goodwill arising from acquisitions completed in 2000 and
2001. See Notes 1 and 2 of Notes to Consolidated Financial Statements.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Represents cash dividends paid in 1999 to holders of shares of Series B Redeemable Preferred Stock, all of which were redeemed
in connection with our initial public offering in August 1999.                                                                 

|                                 |  |              |       |      |  |      |        |      |  |      |        |  |  |   |         |  |  |   |         | 
|-------------------------------- |  | ------------ | ----- | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------- |  |  | - | ------- | 
|(In thousands)                   |  | December 31,
|                                 |  |             
|                                 |  | 1997         |       | 1998 |  | 1999 |        | 2000 |  | 2001
|                                 |  |              |       |      |  |      |        |      |  |     
|Consolidated Balance Sheet Data: |  |              |       |      |  |      |        |      |  |      |        |  |  |   |         |  |  |   |         | 
|                                
|                                
|                                
|                                
|Cash and cash equivalents        |  | $            | 2,096 |      |  | $    | 8,981  |      |  | $    | 39,643 |  |  | $ | 25,155  |  |  | $ | 30,279  | 
|                                
|                                
|                                
|                                
|Short-term marketable securities |  |              |      |      |  |      |       |      |  |      | 11,000 |  |  |   | 8,587   |  |  |   | 23,039  | 
|                                
|                                
|                                
|                                
|Working capital                  |  |              | 374   |      |  |      | 2,771  |      |  |      | 38,670 |  |  |   | 29,887  |  |  |   | 15,799  | 
|                                
|                                
|                                
|                                
|Total assets                     |  |              | 9,713 |      |  |      | 19,645 |      |  |      | 99,149 |  |  |   | 534,172 |  |  |   | 540,125 | 
|                                
|                                
|                                
|                                
|Long-term obligations            |  |              |      |      |  |      |       |      |  |      | 403    |  |  |   | 6,422   |  |  |   | 5,140   | 
|                                
|                                
|                                
|                                
|Total shareholders equity       |  |              | 2,836 |      |  |      | 5,074  |      |  |      | 62,669 |  |  |   | 458,354 |  |  |   | 441,368 | 

10



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##### Table of Contents






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.
Certain statements in this report, including statements regarding our business
strategies, operations, financial conditions and prospects, are forward-looking
statements. Use of the words believe, expect, anticipate, will,
contemplate, would and similar expressions that contemplate future events
may identify forward-looking statements.

Numerous important factors, risks and uncertainties affect our operations and
could cause actual results to differ materially from those expressed or implied
by these or any other forward-looking statements made by us or on our behalf.
Readers are urged to carefully review and consider the various disclosures made
in this report, including those described under Risk Factors, and in other
filings with the SEC, that attempt to advise interested parties of certain
risks and factors that may affect our business. Readers are cautioned not to
place undue reliance on these forward-looking statements, which are based on
current expectations and reflect managements opinions only as of the date
thereof. We do not assume any obligation to revise or update forward-looking
statements. Finally, our historic results should not be viewed as indicative of
future performance.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to
make estimates and judgments that affect our reported assets, liabilities,
revenues and expenses. On an on-going basis, we evaluate our estimates,
including those related to revenue recognition, accounts receivable, intangible
assets and deferred income taxes. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. This forms the basis of judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe the following critical accounting policies and the related
judgments and estimates affect the preparation of our consolidated financial
statements.

Revenue
Recognition

We record revenue in accordance with Financial Accounting Standards Board
(FASB) Statement of Position (SOP) 97-2, Software Revenue Recognition, as
amended.
We license our products through our direct sales force and indirectly through
resellers. 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. Deferred
license revenue represents sales in which the Company has received some
payments but all of the requirements of SOP 97-2 have not been met. Revenue
from post-contract customer support is deferred and recognized ratably over the
term of the contract. Revenue from consulting and training services are
recognized as the services are performed.

Accounts
Receivable

We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. The
amount of our reserves is based on historical experience and our analysis of
the accounts receivable less balances outstanding. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required which would
result in an additional general and administrative expense in the period such
determination was made. While such credit losses have historically been within
our expectations and the provisions established, we cannot guarantee that we
will continue to experience the same credit loss rates that we have in the
past.

Intangible
Assets

We record goodwill arising from acquisitions as the excess of the purchase
price over the fair value of assets acquired and was being amortized over a
useful life of five years. In July 2001, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards, or SFAS, No. 141,
Business

11



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##### Table of Contents



Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS 141 requires that all business combinations be accounted for using the
purchase method and provides new criteria for recording intangible assets
separately from goodwill. Existing goodwill and intangible assets will be
evaluated against these new criteria, which may result in certain intangible
assets being subsumed into goodwill. SFAS 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets. Goodwill and
intangible assets that have indefinite useful lives will not be amortized into
results of operations, but instead will be evaluated at least annually for
impairment and written down when the recorded value exceeds the estimated fair
value. The Company adopted the provisions of each statement on January 1, 2002.
As a result, the Company has ceased amortization of goodwill, reducing annual
amortization expense by approximately $57.0 million. The Company is evaluating
the full impact of adopting the new standards. In addition, impairment reviews
may result in charges against earnings to write down the value of goodwill.

Purchased intangible assets are recorded at the appraised value of
technology, workforce and customer lists acquired and amortized using the
straight-line method over estimated useful lives of three years to six years.
The net carrying amount of purchased intangible assets was considered
recoverable at December 31, 2001. We will continue to evaluate our purchased
intangible assets value on a periodic basis. In the event that in the future,
it is determined that the purchased intangible assets value has been impaired,
an adjustment will be made resulting in a charge for the write-down in the
period in which the determination was made.

Deferred
Taxes

We recognize deferred income tax assets and liabilities based upon the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. Such deferred income taxes primarily relate to the
timing of the recognition of certain revenue items and the timing of the
deductibility of certain reserves and accruals for income tax purposes. We
regularly review the deferred tax assets for recoverability and establish a
valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized. If we are unable to generate
sufficient future taxable income, or if there is a material change in the
actual effective tax rates or time periods within which the underlying timing
differences become taxable or deductible, we could be required to establish an
additional valuation allowance against the deferred tax assets which could
result in a substantial increase in our effective tax rate and have a
materially adverse impact on our operating results.

Overview

We provide application management software solutions that enhance our
customers return on IT investment dollars by maximizing the availability,
performance and manageability of business critical applications and their
underlying databases and other associated components and by improving the cost
effectiveness of a customers information technology investments, including
personnel, software and hardware. The systems that our products manage include
ERP (enterprise resource planning) systems, CRM (customer relationship
management) systems, B2B (business to business) e-commerce systems, corporate
messaging and Internet-based applications. Information about our various
products is provided above under in Item 1. Business.

Our revenues comprise software license fees and services fees. Our
software licensing model is based on perpetual license fees, and our licenses
are either server-based or, for our SQL development and report management
tools, user-based. Service revenues consist primarily of annual maintenance
contracts for technical support and product enhancements. Service revenues also
include consulting services and training revenues.

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Results of Operations

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

|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |       | 
|----------------------------------------- | -------------------------------------------------- | ------------------------ | ---- | ----------------------- | ----- | ---- | ----- | ---- | ----- |  | ----- | ---- | ----- | 
|                                          |                                                    |                          |      | Year Ended December 31,
|                                          |                                                    |                          |      |                        
|                                          |                                                    |                          |      | 1999                    |       | 2000 |       | 2001
|                                          |                                                    |                          |      |                         |       |      |       |     
|Revenues:                                 |                                                    |                          |      |                         |       |      |       |      |       |  |       |     
|                                         
|                                         
|                                         
|                                         
|                                          | Licenses                                           |                          |      | 76.6                    | %     |      |       | 76.6 | %     |  |       | 71.0 | %    
|                                         
|                                         
|                                         
|                                         
|                                          | Services                                           |                          |      | 23.4                    |       |      |       | 23.4 |       |  |       | 29.0 |      
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|                                          |                                                    | Total revenues           |      |                         | 100.0 |      |       |      | 100.0 |  |       |      | 100.0 | 
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|Cost of revenues:                         |                                                    |                          |      |                         |       |      |       |      |       |  |       |     
|                                         
|                                         
|                                         
|                                         
|                                          | Licenses                                           |                          |      | 4.2                     |       |      |       | 2.2  |       |  |       | 1.8  |      
|                                         
|                                         
|                                         
|                                         
|                                          | Services                                           |                          |      | 5.9                     |       |      |       | 6.5  |       |  |       | 7.1  |      
|                                         
|                                         
|                                         
|                                         
|                                          | Amortization of purchased intangible assets        |                          |      |                        |       |      |       | 3.0  |       |  |       | 3.3  |      
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|                                          |                                                    | Total cost of revenues   |      |                         | 10.1  |      |       |      | 11.7  |  |       |      | 12.2  | 
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|Gross profit                              |                                                    |                          | 89.9 |                         |       |      | 88.3  |      |       |  | 87.8  |     
|                                         
|                                         
|                                         
|                                         
|Operating expenses:                       |                                                    |                          |      |                         |       |      |       |      |       |  |       |     
|                                         
|                                         
|                                         
|                                         
|                                          | Sales and marketing                                |                          |      | 45.3                    |       |      |       | 46.9 |       |  |       | 49.7 |      
|                                         
|                                         
|                                         
|                                         
|                                          | Research and development                           |                          |      | 22.6                    |       |      |       | 24.0 |       |  |       | 24.3 |      
|                                         
|                                         
|                                         
|                                         
|                                          | General and administrative                         |                          |      | 14.0                    |       |      |       | 10.7 |       |  |       | 9.8  |      
|                                         
|                                         
|                                         
|                                         
|                                          | Other compensation costs and goodwill
amortization |                          |      | 1.8                     |       |      |       | 24.8 |       |  |       | 26.0 |      
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|                                          |                                                    | Total operating expenses |      |                         | 83.7  |      |       |      | 106.4 |  |       |      | 109.8 | 
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|Income (loss) from operations             |                                                    |                          | 6.2  |                         |       |      | (18.1 | )    |       |  | (22.0 | )   
|                                         
|                                         
|                                         
|                                         
|Other income (expense), net               |                                                    |                          | 1.7  |                         |       |      | 7.0   |      |       |  | 3.3   |     
|                                         
|                                         
|                                         
|                                         
|Losses on equity investments              |                                                    |                          |     |                         |       |      |      |      |       |  | (1.8  | )   
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|Income (loss) before income tax provision |                                                    |                          | 7.9  |                         |       |      | (11.1 | )    |       |  | (20.5 | )   
|                                         
|                                         
|                                         
|                                         
|Income tax provision                      |                                                    |                          | 3.2  |                         |       |      | 4.1   |      |       |  | 2.4   |     
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      
|Net income (loss)                         |                                                    |                          | 4.7  | %                       |       |      | (15.2 | )%   |       |  | (22.9 | )%  
|                                          |                                                    |                          |      |                         |       |      |       |      |       |  |       |      |      

Years Ended December 31, 1999, 2000 and 2001

Revenues

Revenues were $70.9 million, $165.6 million and $245.4 million in 1999,
2000 and 2001, respectively, representing increases of $94.7 million, or
133.6%, from 1999 to 2000, and $79.8 million, or 48.2%, from 2000 to 2001.
North American revenues, which include the United States, Canada, and Mexico,
accounted for 78.4%, 82.6%, and 80.3% of total revenues for 1999, 2000, and
2001, respectively. The rest of the worlds revenues accounted for 21.6%, 17.4%
and 19.7% of total revenues for 1999, 2000 and 2001, respectively. No single
customer accounted for more than 10% of total revenues in 1999, 2000 or 2001.

License Revenues - License revenues were $54.3 million, $126.8 million
and $174.1 million in 1999, 2000 and 2001, respectively, representing increases
of $72.5 million, or 134%, from 1999 to 2000, and $47.3 million, or 37.3%, from
2000 to 2001. License revenues represented 76.6%, 76.6% and 71.0% of total
revenues in 1999, 2000 and 2001, respectively. North American license revenues
accounted for 76.6%, 81.0%, and 78.1% of total license revenues for 1999, 2000,
and 2001, respectively. The rest of the worlds license revenues accounted for
23.4%, 19.0% and 21.9% of total

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license revenues in 1999, 2000 and 2001, respectively. License revenue
growth in 2000 and 2001 derived from higher unit volumes, sales force expansion
and new product introductions. Our ability to close larger individual sales
transactions also contributed to license revenue growth in these periods. Price
increases did not contribute to license revenue growth.

The increase in license revenues from 1999 to 2000 was due to expansion of
our worldwide sales force, as well as increased market acceptance of our
software products and introduction of new products. The increase in license
revenues from 2000 to 2001 was primarily due to continued expansion of our
worldwide sales force, and to a greater extent increased market acceptance of
existing products, including LiveReorg, and the successful introduction of new
products, including Quest Central for DB2 and the Fastlane products we acquired
in September 2000 for managing Microsoft Windows 2000 environments.

Service Revenues  Service revenues were $16.6 million, $38.8 million, and
$71.2 million in 1999, 2000 and 2001, respectively, representing increases of
$22.2 million, or 134%, from 1999 to 2000, and $32.4 million, or 83.5% from
2000 to 2001. Service revenues represented 23.4%, 23.4% and 29.0% of total
revenues in 1999, 2000 and 2001, respectively. Maintenance and support
revenues represent the bulk of services revenues. Maintenance and support
revenues represent the ratable recognition of fees to enroll licensed products
in our software maintenance, enhancement and support program. Maintenance and
support enrollment entitles customers to product enhancements, technical
support services and ongoing compatibility with third-party operating systems,
database management systems and applications. These fees are generally charged
annually and equal 20% to 25% of the discounted price of the product.
Maintenance revenues also include the ratable recognition of the bundled fees
for any first-year maintenance services covered by the related perpetual
license agreement. The growth in service revenues in 2000 and 2001 reflect the
increase in first year maintenance and support fees associated with the growth
in product license sales. The growth in service revenues in 2001 also derived
from high support renewal fees as the installed base of customers grew and we
significantly improved our support renewal billing processes. To a much lesser
extent, consulting services revenue growth contributed to service revenue
growth in 2000 and 2001. North American service revenues accounted for 84.0%,
88.0%, and 85.6% of total service revenues for 1999, 2000, and 2001,
respectively. The rest of the worlds service revenues accounted for 16.0%,
12.0% and 14.4% of total service revenues in 1999, 2000 and 2001, respectively.

Cost of Revenues

Cost of Licenses  Cost of licenses primarily consists of third-party
software royalties, product packaging, documentation, duplication, and
amortization of purchased software rights. Cost of licenses was $3.0 million,
$3.6 million and $4.5 million in 1999, 2000 and 2001, respectively,
representing an increase of $0.6 million, or 20%, from 1999 to 2000, and an
increase of $.9 million, or 25%, from 2000 to 2001. Cost of licenses as a
percentage of license revenues was 5.5%, 2.8% and 2.6% for 1999, 2000 and 2001,
respectively. The increase in cost of licenses from 1999 to 2000 was
principally a result of an increase in product media, duplication and printing
costs. The improvement in gross margin from 1999 to 2000 resulted from
increased license revenues without a corresponding increase in amortization of
acquired software rights. Acquired software rights are amortized on a
straight-line basis. The increase in absolute dollars in cost of licenses from
2000 to 2001 was primarily due to increased software royalties partially offset
by a reduction in printing costs in 2001.

Cost of Services  Cost of services primarily consists of personnel
related costs and facilities and systems costs used in providing support,
consulting, and training services. Cost of services was $4.2 million, $10.7
million and $17.4 million in 1999, 2000 and 2001, respectively, representing
increases of $6.5 million, or 155%, from 1999 to 2000, and $6.7 million, or
62.6%, from 2000 to 2001. Cost of services as a percentage of service revenues
was 25.3%, 27.6% and 24.4% for 1999, 2000 and 2001, respectively. The dollar
cost increase in cost of services is primarily due to the increase in the
number of technical support personnel required to manage and support our
growing customer base as well as increased product offerings. As a percentage
of service revenues, costs of services increased from 25%

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to 28% in 2000, but decreased to 24% in 2001. The increase in service margin in
2000 was attributable to investments in our support organization infrastructure
including a customer relationship management system. The decrease in 2001 was
driven by increased tenure and productivity of technical support personnel and
increased stability of enhanced products in our installed base.

Amortization of Purchased Intangible Assets - Amortization of purchased
intangible assets, which includes amortization of the fair value of acquired
technology, workforce and customer lists associated with the acquisitions made
during 2000 and 2001, was $5.0 million in 2000 and $8.0 million in 2001,
representing an increase of $3.0 million, or 60.0%. There were no similar costs
during 1999. Intangible assets purchased as part of acquisitions were $25.4
million, and $3.2 million in 2000 and 2001, respectively. The increase in
amortization from 2000 to 2001 was due entirely to technology purchased as part
of the acquisitions made during the third quarter of 2000. In the third quarter
of 2000, we added $16.0 million of purchased intangible assets, as a result
incurring a full year of amortization in 2001 compared to approximately three
months in 2000. The useful lives of the technology acquired range from one to
three years, and we expect the amortization to be at least $1.0 million per
quarter over the next four quarters. See Critical Accounting Policies and
Estimates for additional discussion on potential impact of the implementation
of SFAS No. 142, Goodwill and Other Intangible Assets.

Operating Expenses

Sales and Marketing Sales and marketing expenses consist primarily of
salaries, sales commissions benefits, recruiting costs, trade shows, travel and
entertainment and other marketing communications costs such as advertising and
promotion. Sales and marketing expenses were $32.1 million, $77.6 million and
$121.9 million in 1999, 2000 and 2001, respectively, representing increases of
$45.5 million, or 142.0%, from 1999 to 2000, and $44.3 million, or 57.1%, from
2000 to 2001. Sales and marketing as a percentage of total revenues for 1999,
2000, and 2001 was 45.3%, 46.9%, and 49.7%, respectively.

The increases from 1999 to 2000 included an increase in salaries and
related expenses of $20.3 million, an $8.9 million increase in commissions,
$5.3 million increase in travel and related costs, and a $1.6 million increase
in promotional, conference and tradeshow expenses. Increases from 2000 to 2001
included an increase in salaries and related expenses of $21.6 million, a $6.0
million increase in commissions, $4.0 million increase in travel and related
costs, and a $2.2 million increase in office lease expenses. The increases
reflect our investment in our sales and marketing organization. In particular,
sales and marketing employees increased from 299 as of December 31, 1999 to 614
as of December 31, 2000, an increase of 105%, and to 690 as of December 31,
2001, an increase of 12.4%. Commissions were higher year-over-year as a result
of increased license revenues. Sales and marketing expenses decreased as a
percentage of revenues in the first and second quarters of 2001, but then
increased to 52% and 51% in the third and fourth quarters, respectively, as
revenues declined more than expenses in the aftermath of the September 11
attacks on the United States.

Research and Development  Research and development expenses consist
primarily of salaries and benefits for software developers, software product
managers, quality assurance and technical documentation personnel, and of
payments made to outside software development contractors. Research and
development expenses were $16.0 million, $39.7 million and $59.5 million in
1999, 2000 and 2001, respectively, representing increases of $23.7 million, or
148%, from 1999 to 2000, and $19.8 million, or 49.9%, from 2000 to 2001.
Research and development as a percentage of total revenues in 1999, 2000, and
2001 was 22.6%, 24.0%, and 24.3%, respectively.

The changes in these periods were primarily related to increases in the
number of personnel conducting research and development, including software
developers and technical documentation and quality assurance personnel
associated with new product initiatives and the integration of software
products associated with companies acquired during 1999 and 2000. The change in
research and development as a percentage of total revenues remained relatively
flat from 2000 to 2001 as a

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result of lower than expected license revenues in the last two quarters
offset by a reduction in year-over-year headcount increases. We believe
significant expenditures in research and development are required to remain
competitive, and expect that research and development expenses will continue to
represent 20-25% of total revenues for the foreseeable future.

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.

General and Administrative  General and administrative expenses consist
primarily of salaries, benefits and related costs for our executive, finance,
administrative and information services personnel. General and administrative
expenses were $9.9 million, $17.7 million and $24.0 million in 1999, 2000 and
2001, respectively, representing an increase of $7.8 million, or 78%, from 1999
to 2000, and $6.3 million, or 35.6%, from 2000 to 2001. General and
administrative expenses as a percentage of total revenues in 1999, 2000, and
2001 was 14.0%, 10.7%, and 9.8%, respectively. The dollar increase in general
and administrative expenses was primarily due to the increase in headcount to
support our growing infrastructure and expanding operations. General and
administrative expenses are decreasing as a percentage of total revenues,
primarily because associated headcount is growing at a slower rate than
revenues.

Other Compensation Costs and Intangible Amortization - Other compensation
costs and intangible amortization include compensation expense associated with
the issuance (primarily in 1999) of stock options with exercise prices below
fair market value and the amortization of goodwill and other intangible assets
associated with acquisitions. Other compensation costs and goodwill
amortization was $1.2 million, $41.1 million and $63.7 in 1999, 2000 and 2001,
respectively.

Included in 1999 was $0.7 million related to the severance package
provided to one of our founders and a director, which is being paid out over a
three-year period ending in April 2002, $0.4 million of compensation costs
related to the grant of stock options at less than fair market value and $0.1
million of goodwill amortization related to acquisitions.

In 2000 and 2001, these costs consisted of goodwill amortization of $36.0
million and $56.7 million, respectively, related to the various acquisitions
primarily made during 2000 and compensation costs of $5.1 million and $7.0
million, respectively, primarily related to the grant of stock options with
exercise prices at less than fair market value. The majority of the option
grants with exercise prices at less than fair market value were made in 1999.
The cost associated with these grants was $3.4 million in 2000 and $4.5 million
in 2001. We expect the future cost of these grants to be approximately $3.5
million in 2002 and $1.7 million, thereafter. The increase in goodwill
amortization from 2000 to 2001 was due entirely to the acquisitions made during
the third quarter of 2000. In the third quarter of 2000, we added $121.3
million of goodwill, as a result incurring a full year of amortization in 2001
compared to approximately three months in 2000.

In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 141, Business Combinations and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141 requires that
all business combinations be accounted for using the purchase method and
provides new criteria for recording intangible assets separately from goodwill.
Existing goodwill and intangible assets will be evaluated against these new
criteria, which may result in certain intangible assets being subsumed into
goodwill. SFAS 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. Goodwill and intangible assets that have
indefinite useful lives will not be amortized into results of operations, but
instead will be evaluated at least annually for impairment and written down
when the recorded value exceeds the estimated fair value. The Company adopted
the provisions of each statement on January 1, 2002. As a result, the Company
has ceased amortization of goodwill, reducing annual amortization expense by
approximately $57.0 million. The Company is evaluating the full impact of
adopting the new standards. In addition, impairment reviews may result in
charges against earnings to write down the value of goodwill.

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Other
Income (Expense), Net - Other income (expense), net consists
primarily of interest income and expense. Other income (expense), net was $1.2
million in 1999, $11.6 million in 2000 and $8.2 million in 2001, representing
an increase of $10.4 million from 1999 to 2000, and a $3.4 million decrease
from 2000 to 2001. The increase from 1999 to 2000 was due to increased interest
income from higher cash and short-term investments, which accelerated after the
receipt of the net proceeds of our initial public offering in 1999 and our
secondary offering in March 2000. The decrease from 2000 to 2001 is primarily
due to lower interest rates and reduced cash balances resulting from
application of the net proceeds from public offerings in August 1999 and March
2000. The average interest rates of our investments are summarized under Item
7a: Quantitative and Qualitative Disclosures About Market Risks  Interest Rate
Risk.

Losses on Equity Investments  During 2001 we recognized a non-cash
charge of $4.4 million to write down the carrying value of certain equity
investments to reflect their estimated fair value. These investments are
privately held information technology companies, many of which are in the
start-up or development stage. These investments are carried at cost, subject
to adjustment for other than temporary impairment. We determined that the
decline in value in these in these investments was other than temporary and
recognized an impairment loss.

Provision for Income Taxes  Provision for income taxes was $2.3 million,
$6.8 million and $5.9 million in 1999, 2000 and 2001, respectively,
representing an increase of $4.5 million, or 196%, from 1999 to 2000, and a
decrease of $0.9 million, or (13.2)%, from 2000 to 2001. The effective income
tax rate was 40.1%, (37.2)% and (11.7)% in 1999, 2000 and 2001, respectively.
The change in the effective tax rate from 1999 to 2000 and from 2000 to 2001
results primarily from an increase in non-deductible goodwill amortization
associated with acquisitions completed in 2000 and 2001. See Note 6 to our consolidated financial statements.

Net Income (Loss) Applicable to Common Shareholders - Net income
applicable to common shareholders was $2.8 million in 1999 and reflects
dividend payments of $590,000 to holders of the Companys Series B Preferred
Stock that were redeemed in 1999 in connection with the Companys initial
public offering. There were no such payments in 2000 or 2001.

Inflation

Inflation has not had a significant effect on our results of operations or
financial position for the years ended December 31, 1999, 2000 and 2001.

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, and net proceeds of $253.6 million from our secondary offering
in March 2000. Our sources of liquidity as of December 31, 2001 consisted
principally of cash and cash equivalents of $30.3 million, and $176.9 million
in both short-and long-term investment grade corporate and government
marketable securities.

Net cash provided by operating activities was $11.4 million, $25.9 million
and $64.5 million in 1999, 2000 and 2001, respectively. The increase from 2000
to 2001 is due primarily to higher non-cash depreciation and amortization
expenses as a result of increased other compensation costs, amortization of
goodwill, and other intangible assets, which increased by $25.6 million, or
55.5%, over the comparable period of 2000.

Net cash used in investing activities was $24.1 million, $241.8 million
and $72.2 million in 1999, 2000, and 2001, respectively. The increase in cash
used in investing activities in 2000 was primarily related to net purchases of
marketable securities of $111.0 million, acquisitions of $82.1 million, and
capital expenditures of $39.2 million. Capital expenditures primarily consisted
of equipment and related purchases to support our worldwide expansion and
related infrastructure needs. The decrease in 2001 is due to purchases of
marketable securities made in

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March of 2000 as a result of our secondary public offering as well as
acquisitions made during the first and second quarter of 2000 with dissimilar
activity in 2001.

Financing activities generated $43.6 million, $201.1 million and $12.9
million in 1999, 2000, and 2001, respectively. 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 8.4 million shares of our
common stock at a price of $70.00 per share. Of the shares sold in the offering
3.8 million shares were sold by the Company and 4.6 million shares were sold by
existing shareholders. The company did not receive any proceeds from the
shares sold by the selling shareholders. Due to an absence of significant
capital raising activities in 2001, financing activities generated
significantly less cash than the previous two periods.

In
December 2000, our Board of Directors authorized a stock repurchase
program under which Quest may purchase up to two million shares of its common
stock. Under the repurchase program, we may purchases shares from time to time
at varying prices in open market or private transactions. During 2000, we
repurchased 1.7 million shares for $57.4 million.

In October 2001, our Board of Directors increased the total number of
shares authorized for repurchase under the stock repurchase program from two
million shares to five million. No additional shares were repurchased in 2001.

As of December 31, 2001, our only significant contractual obligations or
commercial commitments consisted of our facility lease commitments and
operating leases for office facilities and certain items of equipment. These
commitments will require cash payments of $11.5 million in 2002, $9.8 million
in 2003, $7.6 million in 2004, $6.2 million in 2005 and $3.6 million
thereafter. We do not have any off-balance sheet arrangements that could
significantly reduce our liquidity. We would be required to use existing cash,
cash equivalents and investment balances to support our working capital
balances if we are not able to generate or sustain positive cash flow from
operations. Our ability to generate cash from operations is subject to
substantial risks described below under the caption Risk Factors.

Based on our current operating plan, we believe that our existing cash,
cash equivalents and investment balances and cash flows from operations will be
sufficient to finance our working capital and capital expenditure requirements
through at least the next 12 months. However, if events occur or circumstances
change such that we fail to meet our operating plan as expected, we may require
additional funds to support our working capital requirements or for other
purposes and may seek to raise additional funds through public or private
equity or debt financing or from other sources. If additional financing is
needed, we can not assure you that such financing will be available to us on
commercially reasonable terms or at all.

Recently Issued Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 141, Business Combinations and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141 requires that
all business combinations be accounted for using the purchase method and
provides new criteria for recording intangible assets separately from goodwill.
Existing goodwill and intangible assets will be evaluated against these new
criteria, which may result in certain intangible assets being subsumed into
goodwill. SFAS 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. Goodwill and intangible assets that have
indefinite useful lives will not be amortized into results of operations, but
instead will be evaluated at least annually for impairment and written down
when the recorded value exceeds the estimated fair value. The Company adopted
the provisions of each statement on January 1, 2002. As a result, the Company
has ceased amortization of goodwill, reducing annual amortization expense by
approximately $57.0 million. The Company is evaluating the

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full impact of adopting the new standards. In addition, impairment reviews
may result in charges against earnings to write down the value of goodwill.

In August 2001, the FASB issued Statement of Financial Accounting Standard
No. 143 (SFAS 143), Accounting for Asset Retirement Obligations, which
addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 is required to be adopted for fiscal years
beginning after June 15, 2002. The Company has not yet determined what effect
this statement will have on its financial statements.

Also in August 2001, the FASB issued Statement of Financial Accounting
Standard No. 144 (SFAS 144), Accounting for the Impairment or Disposal of
Long-Lived Assets, which supersedes FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.
This new statement also supersedes certain aspects of Accounting Principles
Board (APB) 30, Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions, with regard to reporting the
effects of a disposal of a segment of a business and will require expected
future operating losses from discontinued operations to be reported in
discontinued operations in the period incurred (rather than as of the
measurement date as presently required by APB 30). In addition, more
dispositions may qualify for discontinued operations treatment. The provisions
of this statement are required to be applied for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The Company
has not yet determined what effect this statement will have on its financial
statements.

RISK FACTORS

An investment in our shares involves risks and uncertainties. You should
carefully consider the factors described below before making an investment
decision in our securities. The risks described below are the risks that we
currently believe are material risks of business and the industry in which we
compete.

Our business, financial condition and results of operations could be adversely
affected by any of the following risks. If we are adversely affected by such
risks, then the trading price of our common stock could decline, and you could
lose all or part of your investment.

Risks Related to Our Business

Our quarterly operating results may fluctuate in future periods and, as a
result, we may fail to meet expectations of investors and analysts, causing our
stock price to fluctuate or decline

Our revenues and operating results may vary significantly from quarter to
quarter due to a number of factors. These factors include the following:

     the size and timing of customer orders. See  The size and timing of our
customer orders may vary significantly from quarter
           to
quarter which could cause fluctuations in our revenues.

     the unpredictability of the timing and level of sales through our indirect
sales channel;

     the timing of revenue recognition for sales of software products and services;

     the extent to which our customers renew their maintenance contracts with us;

     exposure to general economic conditions and reductions in corporate IT
spending;

     changes in our level of operating expenses and our ability to control costs;

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

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

     the relative growth rates of competing operating system, database and
application platforms;

     costs related to acquisitions of technologies or businesses, including
amortization of goodwill and other intangible assets; and

     the timing of releases of new versions of third-party software products that
our products support.

Fluctuations in our results of operations are likely to affect the market price
of our common stock that may not be related to our long-term performance.

The size and timing of our customer orders may vary significantly from quarter
to quarter which could cause fluctuations in our revenues and operating results

Our license revenues in any quarter are substantially dependent on orders
booked and shipped in that quarter. Our revenues in a given quarter could be
adversely affected if we are unable to complete one or more large license
agreements, or if the contract terms were to prevent us from recognizing
revenue during that quarter. The sales cycles for certain of our software
products, such as Vista Plus and SharePlex, can last from three to nine months
and often require pre-purchase evaluation periods and customer education. Also,
we have often booked a large amount of our sales in the last month, weeks or
days 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. These
factors may cause significant periodic variation in our license revenues. In
addition, we incur or commit to operating expenses based on anticipated revenue
levels, and generally do not know whether revenues in any quarter will meet
expectations until the end of that quarter. Accordingly, if our revenue growth
rates slow or our revenues decline, our operating results could be seriously
impaired because many of our expenses are relatively fixed in nature and cannot
be easily or quickly changed.

General economic conditions and reductions in corporate IT spending may
continue to affect revenue growth rates and impact our business

Our business and operating results are subject to the effects of changes in
general economic conditions. Recent unfavorable economic conditions have
resulted in reduced corporate IT spending in the industries that we serve and a
softening of demand for computer software, not only in the database and
application market segments we support but also in the product segment in which
we compete. In addition, recent terrorist attacks upon the United States have
added or exacerbated economic, political and other uncertainties. If these
economic conditions do not improve, or we experience continued deterioration in
general economic conditions or reduced corporate IT spending, our business and
operating results could be adversely impacted.

Many of our products are dependent on Oracles technologies; if Oracles
technologies lose market share or become incompatible with our products, the
demand for our products could suffer

We believe that our success has depended in part, and will continue to depend
in part for the foreseeable future, upon our relationship with Oracle and our
status as a complementary software provider for Oracles database and
application products. Many versions of our products, including SharePlex and
SQLab Vision, are specifically designed to be used with Oracle databases.
Although a number of our products work with other environments, our competitive
advantage consists in substantial part on the integration between our products
and Oracles products, and our extensive knowledge of Oracles technology.
Currently, a significant portion of our total revenues are derived from
products that specifically support Oracle-based products. If Oracle for any
reason decides to promote technologies and standards

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that are not compatible with our technology, or if Oracle loses market share
for its database products, our business, operating results and financial
condition would be materially adversely affected.

Many of our products are vulnerable to direct competition from Oracle

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

Our success depends on our ability to develop new and enhanced products that
achieve widespread market acceptance

Our future success depends on our ability to address the rapidly changing needs
of our customers by developing and introducing new products, product updates
and services on a timely basis, by extending the operation of our products on
new platforms and by keeping pace with technological developments and emerging
industry standards. In order to grow our business, we are committing
substantial resources to developing software products and services for the
applications management market. If this market does not continue to develop as
anticipated, or demand for our products in this market does not materialize or
occurs more slowly than we expect, or if our development efforts are delayed or
unsuccessful, we will have expended substantial resources and capital without
realizing sufficient revenues, and our business and operating results could be
adversely affected.

Acquisitions of companies or technologies may result in disruptions to our
business and diversion of management attention

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

Our 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

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increase in the number of our employees, increasing demands on our operating
and financial systems and personnel, and an expansion in the geographic
coverage of our operations. Our ability to manage our operations and growth
requires us to continue to improve our operational, financial and management
controls, and reporting systems and procedures. We may need to expand our
facilities or relocate some or all of our employees or operations from time to
time to support growth. These relocations could result in temporary disruptions
of our operations or a diversion of managements attention and resources. In
addition, we will be required to hire additional management, financial and
sales and marketing personnel to manage our expanding operations. If we are
unable to manage this growth effectively, our business, operating results and
financial condition may be materially adversely affected.

We may not generate increased business from our current customers, which could
slow our revenue growth in the future

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

Our international operations and our planned expansion of our international
operations exposes us to certain risks

We intend to expand our international sales activities as part of our business
strategy. As a result, we face increasing risks from doing business on an
international basis, including, among others:

     difficulties in staffing and managing foreign operations;

     longer payment cycles;

     seasonal reductions in business activity in Europe;

     increased financial accounting and reporting burdens and complexities;

     potentially adverse tax consequences;

     potential loss of proprietary information due to piracy, misappropriation or
weaker laws regarding intellectual
property                 protection;

     delays in localizing our products;

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

     licenses, tariffs and other trade barriers.

In addition, because our international subsidiaries generally conduct business
in the currency of the country in which they operate, our exposure to exchange
rate fluctuations, which are outside of our control, will increase as our
international operations expand. We have not yet entered into any hedging
transactions to mitigate exposure to foreign currency fluctuations.

Operating in international markets also requires 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.

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Failure to develop strategic relationships could harm our business by denying
us selling opportunities and other benefits

Our current collaborative relationships may not prove to be beneficial to us,
and they may not be sustained. We also may not be able to enter into successful
new strategic relationships in the future, which could have a material adverse
effect on our business, operating results and financial condition. From time to
time, we have collaborated with other companies, including Hewlett-Packard and
Oracle and certain of the national accounting firms that provide system
integration services, in areas such as product development, marketing,
distribution and implementation. We could lose sales opportunities if we fail
to work effectively with these parties. Moreover, we expect that maintaining
and enhancing these and other relationships will become a more meaningful part
of our business strategy in the future. However, many of our current partners
are either actual or potential competitors with us. In addition, many of these
third parties also work with competing software companies and we may not be
able to maintain these existing relationships, due to the fact that these
relationships are informal or, if written, are terminable with little or no
notice.

Our proprietary rights may be inadequately protected, and there is risk of
infringement claims or independent development of competing technology that
could harm our competitive position

Our success and ability to compete are dependent on our ability to develop and
maintain the proprietary aspects of our technology. We rely on a combination of
trademark, trade secret, copyright law and contractual restrictions to protect
the proprietary aspects of our technology.

Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy aspects of our products or to obtain and use information that
we regard as proprietary. Litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets, and to
determine the validity and scope of the proprietary rights of others. Any such
resulting litigation could result in substantial costs and diversion of
resources.

Our means of protecting our proprietary rights may prove to be inadequate and
competitors may independently develop similar or superior technology. Policing
unauthorized use of our products is difficult, and we cannot be certain that
the steps we have taken will prevent misappropriation of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. We also believe that,
because of the rapid rate of technological change in the software industry,
trade secret and copyright protection are less significant than factors such as
the knowledge, ability and experience of our employees, frequent product
enhancements and the timeliness and quality of customer support services.

Our success and ability to compete are also dependent on our ability to operate
without infringing upon the proprietary rights of others. Third parties may
claim infringement by us of their intellectual property rights. In the event of
a successful claim of product infringement against us and our failure or
inability to either license the infringed or similar technology or develop
alternative technology on a timely basis, we may incur substantial licensing
fees, be liable for infringement damage, or be unable to market our products.

Our business will suffer if our software
contains errors

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

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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

Certain of our software products contain components developed and maintained by
third-party software vendors. We expect that we may have to incorporate
software from third-party vendors in our future products. We may not be able to
replace the functionality provided by the third-party software currently
offered with our products if that software becomes obsolete, defective or
incompatible with future versions of our products or is not adequately
maintained or updated. Any significant interruption in the availability of
these third-party software products or defects in these products could harm our
sales unless and until we can secure an alternative source. Although we believe
there are adequate alternate sources for the technology licensed to us, such
alternate sources may not provide us with the same functionality as that
currently provided to us.

Natural disasters or power outages could disrupt our business

A substantial portion of our operations are located in California, and we are
subject to risks of damage and business disruptions resulting from earthquakes,
floods and similar events, as well as from power outages. We have recently
experienced limited and temporary power losses in our California facilities due
to power shortages, and we expect in the future to experience additional power
losses. While the impact to our business and operating results has not been
material, we cannot assure you that power losses will not adversely affect our
business in the future, or that the cost of acquiring sufficient power to run
our business will not increase significantly. Since we do not have sufficient
redundancy in our networking infrastructure, a natural disaster or other
unanticipated problem could have an adverse effect on our business, including
both our internal operations and our ability to communicate with our customers
or sell and deliver our products.

Risks Related to Our Industry

The demand for our products will depend on our ability to adapt to rapid
technological change

Our future success will depend on our ability to continue to enhance our
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments and satisfy increasingly
sophisticated customer requirements. Rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer demands and evolving industry standards characterize the market for
our products. The introduction of products embodying new technologies and the
emergence of new

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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 other executive officers. 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.




Item 7a.Quantitative and Qualitative Disclosures About Market Risks

We transact business in a number of different foreign countries around the
world. In most instances, revenues are collected and operating expenses are
paid in the local currency of the country in which we are transacting.
Accordingly, we are exposed to incremental volatility in sales and earnings
within these countries due to fluctuations in foreign exchange rates.

Our exposure to foreign exchange risk is directly proportional to the
magnitude of foreign net profits and losses denominated in currencies other
than the U.S. dollar, as well as our net foreign investment in non-U.S. dollar
assets. These exposures have the potential to produce either gains or losses.
Our cumulative currency gains or losses in any given period are typically
lessened by the economic benefits of diversification and low correlation
between different currencies, but there can be no assurance that this pattern
will continue to be true in future periods.

The foreign currencies to which we currently have the most significant
exposure are the Canadian dollar, the British pound, the Euro and the
Australian dollar.

To date, we have not used derivative financial instruments to hedge our
foreign exchange exposures, nor do we use such instruments for speculative
trading purposes. We regularly monitor the potential cost benefit of hedging
foreign exchange exposures with derivatives and there remains the possibility
that our foreign exchange hedging practices could change accordingly in time.

Interest Rate Risk

Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. We place our investments with
high-quality issuers and, by policy, limit the amount of credit exposure to any
one issuer other than the United States government and its agencies. Our
investments in marketable securities consist primarily of high-grade government
securities with maturities of less than three years. Investments purchased with
an original maturity of three months or less are considered to be cash
equivalents. We classify all of our investments as available-

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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, 2001, the net gain on available-for-sale
securities of $0.5 million comprised 29 positions, of which 23 carried
unrealized gains and 6 carried unrealized losses.

The following table provides information about our investment portfolio at
December 31, 2001 (dollars in thousands):

|                                                     |  |         |         |                    |  |  |      | 
|---------------------------------------------------- |  | ------- | ------- | ------------------ |  |  | ---- | 
|                                                     |  | Balance |         | Average Fixed Rate
|                                                     |  |         |         |                   
|Cash and cash equivalents                            |  | $       | 30,279  |                    |  |  | 3.74 | 
|                                                    
|                                                    
|                                                    
|                                                    
|Short-term marketable securities, available for sale |  |         | 23,039  |                    |  |  | 6.34 | 
|                                                    
|                                                    
|                                                    
|                                                    
|Long-term marketable securities, available for sale  |  |         | 153,838 |                    |  |  | 5.76 | 
|                                                     |  |         |         |                    |  |  |      | 
|Total portfolio                                      |  | $       | 207,156 |                    |  |  | 5.58 | 
|                                                     |  |         |         |                    |  |  |      | 

We consider the carrying value of our investment securities to approximate
their fair value due to the relatively short period of time between origination
of the investments and their expected realization. We also maintain a level of
cash and cash equivalents such that we have generally been able to hold our
investments to maturity. Accordingly, changes in the market interest rate would
not have a material effect on the fair value of such investments.




Item 8.Financial Statements and Supplementary Data

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

The following table sets forth certain quarterly financial data derived
from our unaudited financial statements for the fiscal years ended December 31,
2000 and 2001. Such financial statements have been prepared on the same basis
as the annual Consolidated Financial Statements and include all necessary
adjustments to present fairly such interim financial information. The following
information should be read in conjunction with the Consolidated Financial
Statements and Notes thereto. Historical quarterly results and trends may not
be indicative of future results.

|                                     |  |                                       |        |          |  |           |        |          |  |           |        |          |  |           |        |          |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|------------------------------------ |  | ------------------------------------- | ------ | -------- |  | --------- | ------ | -------- |  | --------- | ------ | -------- |  | --------- | ------ | -------- |  | - | ------- | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                     |  | Quarters Ended                       
|                                     |  |                                      
|                                     |  | March 31,                             |        | June 30, |  | Sept. 30, |        | Dec. 31, |  | March 31, |        | June 30, |  | Sept. 30, |        | Dec. 31,
|                                     |  | 2000                                  |        | 2000     |  | 2000      |        | 2000     |  | 2001      |        | 2001     |  | 2001      |        | 2001    
|                                     |  |                                       |        |          |  |           |        |          |  |           |        |          |  |           |        |         
|                                     |  | (in thousands, except per share data)
|Revenues                             |  | $                                     | 28,725 |          |  | $         | 36,654 |          |  | $         | 44,122 |          |  | $         | 56,085 |          |  | $ | 63,112  |   |  | $ | 66,862  |   |  | $ | 56,339  |   |  | $ | 59,038  |  
|                                    
|                                    
|                                    
|                                    
|Gross profit                         |  |                                       | 25,563 |          |  |           | 32,431 |          |  |           | 39,093 |          |  |           | 49,197 |          |  |   | 56,110  |   |  |   | 59,422  |   |  |   | 48,881  |   |  |   | 51,056  |  
|                                    
|                                    
|                                    
|                                    
|Loss before income tax
provision     |  |                                       | (5,213 | )        |  |           | (1,868 | )        |  |           | (4,434 | )        |  |           | (6,757 | )        |  |   | (9,238  | ) |  |   | (8,564  | ) |  |   | (15,547 | ) |  |   | (16,548 | )
|                                    
|                                    
|                                    
|                                    
|Net loss                             |  | $                                     | (5,685 | )        |  | $         | (4,409 | )        |  | $         | (6,259 | )        |  | $         | (8,724 | )        |  | $ | (14,781 | ) |  | $ | (12,948 | ) |  | $ | (10,841 | ) |  | $ | (17,186 | )
|                                     |  |                                       |        |          |  |           |        |          |  |           |        |          |  |           |        |          |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  
|Basic and diluted net loss
per share |  | $                                     | (0.07  | )        |  | $         | (0.05  | )        |  | $         | (0.07  | )        |  | $         | (0.10  | )        |  | $ | (0.17   | ) |  | $ | (0.15   | ) |  | $ | (0.12   | ) |  | $ | (0.19   | )
|                                     |  |                                       |        |          |  |           |        |          |  |           |        |          |  |           |        |          |  |   |         |   |  |   |         |   |  |   |         |   |  |   |         |  




Item 9.Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

Not applicable.

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PART III




Item 10.Directors and Executive Officers of the Registrant

Information regarding our directors will be included in our definitive
proxy statement, to be delivered to shareholders in connection with our 2002
annual meeting. Such information is incorporated herein by reference.

Information with respect to our executive officers may be found in Part I,
Item 1, under the heading Executive Officers of the Registrant.




Item 11.Executive Compensation

Information regarding compensation of certain named executive officers
will be included in the section captioned Executive Compensation appearing in
our definitive proxy statement, to be delivered to shareholders in connection
with our 2002 annual meeting of shareholders. 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 section
captioned Security Ownership of Certain Beneficial Owners and Management
appearing in our definitive proxy statement, to be delivered to shareholders in
connection with our 2002 annual meeting of shareholders. Such information is
incorporated herein by reference.




Item 13.Certain Relationships and Related Transactions

Information required by this item will be included in the section
captioned Related Party Transactions appearing in our definitive proxy
statement, to be delivered to shareholders in connection with our 2002 annual
meeting of shareholders. Such information is incorporated herein by reference.




PART IV




Item 14.Exhibits, Financial Statement Schedules And Reports On Form 8-K

(a)  The following documents are filed as part of this Form 10-K.

1.     Financial Statements

|                                                                                                     |  |      |     | 
|---------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                     |  | PAGE
|                                                                                                     |  |     
|Independent Auditors Report                                                                         |  |      | F-1 | 
|                                                                                                    
|                                                                                                    
|                                                                                                    
|                                                                                                    
|Consolidated Balance Sheets as of December 31, 2000 and
2001                                         |  |      | F-2 | 
|                                                                                                    
|                                                                                                    
|                                                                                                    
|                                                                                                    
|Consolidated Statements of Operations for the Years Ended
December 31, 1999, 2000 and 2001           |  |      | F-3 | 
|                                                                                                    
|                                                                                                    
|                                                                                                    
|                                                                                                    
|Consolidated Statements of Shareholders Equity for the
Years Ended December 31, 1999, 2000 and 2001 |  |      | F-4 | 
|                                                                                                    
|                                                                                                    
|                                                                                                    
|                                                                                                    
|Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 2000 and 2001           |  |      | F-5 | 
|                                                                                                    
|                                                                                                    
|                                                                                                    
|                                                                                                    
|Notes to Consolidated Financial Statements                                                           |  |      | F-6 | 

2.     Financial Statement Schedules

The following financial statement schedule should be read in conjunction
with the consolidated financial statements of Quest Software, Inc. filed as
part
of this Report:

     Schedule II  Valuation and Qualifying Accounts

Schedules other than that listed above have been omitted since they are
either not required or not applicable or because the information required is
included in the consolidated financial statements included elsewhere herein or
the notes thereto.

27



---



##### Table of Contents



3.     Exhibits

|        |  |                                                                                                                                                    
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                    
|NUMBER  |  | EXHIBIT TITLE                                                                                                                                      
|        |  |                                                                                                                                                    
|3.1     |  | Second Amended and Restated Articles of Incorporation.(1)                                                                                          
|        |  |                                                                                                                                                    
|3.2     |  | Second Amended and Restated Bylaws, as amended.(2)                                                                                                 
|        |  |                                                                                                                                                    
|3.3     |  | Certificate of Amendment of Second Amended and Restated
Articles of Incorporation.(3)                                                              
|        |  |                                                                                                                                                    
|3.4     |  | Certificate of Amendment of Bylaws(4)                                                                                                              
|        |  |                                                                                                                                                    
|4.1     |  | Form of Registrants Specimen Common Stock Certificate.(1)                                                                                         
|        |  |                                                                                                                                                    
|10.1++  |  | Registrants 1998 Stock Option/Stock Issuance Plan.(1)                                                                                             
|        |  |                                                                                                                                                    
|10.2++  |  | Registrants 1999 Stock Incentive Plan.(1)                                                                                                         
|        |  |                                                                                                                                                    
|10.3++  |  | Registrants 1999 Employee Stock Purchase Plan.(1)                                                                                                 
|        |  |                                                                                                                                                    
|10.4    |  | Form of Directors and Officers Indemnification
Agreement.(1)                                                                                     
|        |  |                                                                                                                                                    
|10.5    |  | Office Space Lease dated as of June 17, 1999 between The
Irvine Company and Quest Software, Inc.(1)                                                
|        |  |                                                                                                                                                    
|10.6    |  | Office Lease between The Northwestern Mutual Life Insurance
Company (Landlord) and Quest Software, Inc. (Tenant) dated
as of September 30, 1999.(2)
|        |  |                                                                                                                                                    
|10.7    |  | Office lease, dated June 2000, between Fund VIII and Fund IX
Associates and Quest Software, Inc.(5)                                                
|        |  |                                                                                                                                                    
|10.8++  |  | Registrants 2001 Stock Incentive Plan(6)                                                                                                          
|        |  |                                                                                                                                                    
|21.1    |  | Subsidiaries of the Company.                                                                                                                       
|        |  |                                                                                                                                                    
|23.1    |  | Consent of Deloitte & Touche LLP.                                                                                                                  



---

|(1) |  | Incorporated herein by reference to the Companys Registration
Statement on
Form S-1 and all amendments thereto (File No. 333-80543).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                      
|(2) |  | Incorporated herein by reference to the Companys Registration
Statement on
Form S-1 and all amendments thereto (File No. 333-30816).
|    |  |                                                                                                                                      
|(3) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form
10-Q for the period ended June 30, 2000.                  
|    |  |                                                                                                                                      
|(4) |  | Incorporated herein by reference to the Companys Quarterly Report on Form
10-Q for the period ended June 30, 2001                   
|    |  |                                                                                                                                      
|(5) |  | Incorporated herein by reference to the Companys Annual Report on Form
10-K for the year ended December 30, 2000                    
|    |  |                                                                                                                                      
|(6) |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-8 (File No. 333-82784) filed on February 14, 2002 
|    |  |                                                                                                                                      
|++  |  | Indicates a management contract or compensatory arrangement.                                                                         
|    |  |                                                                                                                                      
|(b) |  | Reports on Form 8-K                                                                                                                  

No reports on Form 8-K were filed by Quest Software, Inc. during the
quarter ended December 31, 2001.

28



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##### Table of Contents






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.
|                     
|                     
|                     
|                     
|                      |  |                      |  |                                       
|                     
|                     
|                     
|                     
|Dated: March 29, 2002 |  | 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.

|                                        |  |                                                                                 |  |               
|--------------------------------------- |  | ------------------------------------------------------------------------------- |  | --------------
|SIGNATURE                               |  | TITLE                                                                           |  | DATE          
|                                        |  |                                                                                 |  |               
|                                       
|/s/ VINCENT C. SMITHVincent C. Smith    |  | Chief Executive Officer
(principal executive officer)
and Chairman of the Board |  | March 29, 2002
|                                       
|/s/ DAVID M. DOYLEDavid M. Doyle        |  | President, Secretary and Director                                               |  | March 29, 2002
|                                       
|/s/ M. BRINKLEY MORSEM. Brinkley Morse  |  | Vice President, Finance and Operations 
(principal financial officer)           |  | March 29, 2002
|                                       
|/s/ KEVIN E. BROOKSKevin E. Brooks      |  | Corporate Controller
(principal accounting officer)                             |  | March 29, 2002
|                                       
|/s/ DORAN G. MACHINDoran G. Machin      |  | Director                                                                        |  | March 29, 2002
|                                       
|/s/ JERRY MURDOCK, JRJerry Murdock, Jr. |  | Director                                                                        |  | March 29, 2002
|                                       
|/s/ RAYMOND J. LANERaymond J. Lane      |  | Director                                                                        |  | March 29, 2002

29



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##### Table of Contents






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, 2000 and
2001, and the related consolidated statements of operations, shareholders
equity, and cash flows for each of the three years in the period ended
December 31, 2001. 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 financial position of Quest Software, Inc. and
its subsidiaries at December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Costa Mesa, California
January 29, 2002

F-1



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##### Table of Contents






QUEST SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)

|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |         | 
|--------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ------------ | ------- | ------------ | ----- | ------- | ------- | 
|                                              |                                                                                                                                                    |                                            |       | December 31, |         | December 31,
|                                              |                                                                                                                                                    |                                            |       | 2000         |         | 2001        
|                                              |                                                                                                                                                    |                                            |       |              |         |             
|ASSETS                                        |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|Current assets:                               |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|                                              | Cash and cash equivalents                                                                                                                          |                                            | $     | 25,155       |         |              | $     | 30,279  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Short-term marketable securities                                                                                                                   |                                            |       | 8,587        |         |              |       | 23,039  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Accounts receivable, net of allowance for doubtful accounts of $1,372
and $895, respectively                                                       |                                            |       | 38,443       |         |              |       | 35,783  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Prepaid expenses and other current assets                                                                                                          |                                            |       | 11,390       |         |              |       | 8,230   |        
|                                             
|                                             
|                                             
|                                             
|                                              | Income taxes receivable                                                                                                                            |                                            |       | 1,558        |         |              |       |        |        
|                                             
|                                             
|                                             
|                                             
|                                              | Deferred income taxes                                                                                                                              |                                            |       | 14,833       |         |              |       | 12,085  |        
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|                                              |                                                                                                                                                    | Total current assets                       |       |              | 99,966  |              |       |         | 109,416 | 
|                                             
|                                             
|                                             
|                                             
|                                              | Property and equipment, net                                                                                                                        |                                            |       | 46,840       |         |              |       | 57,496  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Long-term marketable securities                                                                                                                    |                                            |       | 118,084      |         |              |       | 153,838 |        
|                                             
|                                             
|                                             
|                                             
|                                              | Goodwill and purchased intangible assets, net                                                                                                      |                                            |       | 255,858      |         |              |       | 202,706 |        
|                                             
|                                             
|                                             
|                                             
|                                              | Deferred income taxes                                                                                                                              |                                            |       | 3,001        |         |              |       | 10,902  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Other assets                                                                                                                                       |                                            |       | 10,423       |         |              |       | 5,767   |        
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|                                              |                                                                                                                                                    | Total assets                               |       | $            | 534,172 |              |       | $       | 540,125 | 
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|LIABILITIES AND SHAREHOLDERS EQUITY          |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|Current liabilities:                          |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|                                              | Accounts payable                                                                                                                                   |                                            | $     | 5,503        |         |              | $     | 5,495   |        
|                                             
|                                             
|                                             
|                                             
|                                              | Accrued compensation                                                                                                                               |                                            |       | 9,350        |         |              |       | 12,764  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Other accrued expenses                                                                                                                             |                                            |       | 22,491       |         |              |       | 21,720  |        
|                                             
|                                             
|                                             
|                                             
|                                              | Income taxes payable                                                                                                                               |                                            |       |             |         |              |       | 3,243   |        
|                                             
|                                             
|                                             
|                                             
|                                              | Deferred revenue                                                                                                                                   |                                            |       | 32,052       |         |              |       | 50,395  |        
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|                                              |                                                                                                                                                    | Total current liabilities                  |       |              | 69,396  |              |       |         | 93,617  | 
|                                             
|                                             
|                                             
|                                             
|Long-term liabilities and other               |                                                                                                                                                    |                                            | 6,422 |              |         |              | 5,140 |        
|                                             
|                                             
|                                             
|                                             
|Commitments and contingencies (Notes 2 and 9) |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|Shareholders equity:                         |                                                                                                                                                    |                                            |       |              |         |              |       |        
|                                             
|                                             
|                                             
|                                             
|                                              | Preferred stock, no par value, 10,000 shares authorized; no shares issued or
outstanding                                                           |                                            |       |             |         |              |       |        |        
|                                             
|                                             
|                                             
|                                             
|                                              | Common stock, no par value, 150,000 shares authorized; 86,710 and 89,226 shares issued
and outstanding at December 31, 2000 and 2001, respectively |                                            |       | 500,324      |         |              |       | 537,081 |        
|                                             
|                                             
|                                             
|                                             
|                                              | Accumulated deficit                                                                                                                                |                                            |       | (23,214      | )       |              |       | (78,973 | )      
|                                             
|                                             
|                                             
|                                             
|                                              | Accumulated other comprehensive income                                                                                                             |                                            |       | 132          |         |              |       | 522     |        
|                                             
|                                             
|                                             
|                                             
|                                              | Notes receivable from sale of common stock                                                                                                         |                                            |       | (18,888      | )       |              |       | (17,262 | )      
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|                                              |                                                                                                                                                    | Net shareholders equity                   |       |              | 458,354 |              |       |         | 441,368 | 
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        
|                                              |                                                                                                                                                    | Total liabilities and shareholders equity |       | $            | 534,172 |              |       | $       | 540,125 | 
|                                              |                                                                                                                                                    |                                            |       |              |         |              |       |         |        

See accompanying notes to consolidated financial statements.

F-2



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##### Table of Contents






QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |         | 
|--------------------------------------------------- | -------------------------------------------------- | ------------------------ | ------ | ----------------------- | ------ | ---- | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                    |                                                    |                          |        | Year Ended December 31,
|                                                    |                                                    |                          |        |                        
|                                                    |                                                    |                          |        | 1999                    |        | 2000 |         | 2001   
|                                                    |                                                    |                          |        |                         |        |      |         |        
|Revenues:                                           |                                                    |                          |        |                         |        |      |         |         |         |   |         |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Licenses                                           |                          | $      | 54,269                  |        |      | $       | 126,767 |         |   | $       | 174,134 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Services                                           |                          |        | 16,599                  |        |      |         | 38,820  |         |   |         | 71,216  |        
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|                                                    |                                                    | Total revenues           |        |                         | 70,868 |      |         |         | 165,587 |   |         |         | 245,350 | 
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of revenues:                                   |                                                    |                          |        |                         |        |      |         |         |         |   |         |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Licenses                                           |                          |        | 2,998                   |        |      |         | 3,571   |         |   |         | 4,510   |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Services                                           |                          |        | 4,195                   |        |      |         | 10,695  |         |   |         | 17,369  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Amortization of purchased intangible assets        |                          |        |                        |        |      |         | 5,038   |         |   |         | 8,003   |        
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|                                                    |                                                    | Total cost of revenues   |        |                         | 7,193  |      |         |         | 19,304  |   |         |         | 29,882  | 
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Gross profit                                        |                                                    |                          | 63,675 |                         |        |      | 146,283 |         |         |   | 215,468 |        
|                                                   
|                                                   
|                                                   
|                                                   
|Operating expenses:                                 |                                                    |                          |        |                         |        |      |         |         |         |   |         |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Sales and marketing                                |                          |        | 32,078                  |        |      |         | 77,641  |         |   |         | 121,901 |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Research and development                           |                          |        | 15,980                  |        |      |         | 39,747  |         |   |         | 59,548  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | General and administrative                         |                          |        | 9,906                   |        |      |         | 17,679  |         |   |         | 23,993  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Other compensation costs and goodwill amortization |                          |        | 1,243                   |        |      |         | 41,092  |         |   |         | 63,727  |        
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|                                                    |                                                    | Total operating expenses |        |                         | 59,207 |      |         |         | 176,159 |   |         |         | 269,169 | 
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Income (loss) from operations                       |                                                    |                          | 4,468  |                         |        |      | (29,876 | )       |         |   | (53,701 | )      
|                                                   
|                                                   
|                                                   
|                                                   
|Other income, net                                   |                                                    |                          | 1,202  |                         |        |      | 11,603  |         |         |   | 8,208   |        
|                                                   
|                                                   
|                                                   
|                                                   
|Losses on equity investments                        |                                                    |                          |       |                         |        |      |        |         |         |   | (4,405  | )      
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Income (loss) before income tax provision           |                                                    |                          | 5,670  |                         |        |      | (18,273 | )       |         |   | (49,898 | )      
|                                                   
|                                                   
|                                                   
|                                                   
|Income tax provision                                |                                                    |                          | 2,273  |                         |        |      | 6,805   |         |         |   | 5,861   |        
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Net income (loss)                                   |                                                    |                          | 3,397  |                         |        |      | (25,078 | )       |         |   | (55,759 | )      
|                                                   
|                                                   
|                                                   
|                                                   
|Preferred stock dividends                           |                                                    |                          | 590    |                         |        |      |        |         |         |   |        |        
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Net income (loss) applicable to common shareholders |                                                    | $                        | 2,807  |                         |        | $    | (25,078 | )       |         | $ | (55,759 | )      
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Net income (loss) per share:                        |                                                    |                          |        |                         |        |      |         |         |         |   |         |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Basic                                              |                          | $      | 0.04                    |        |      | $       | (0.29   | )       |   | $       | (0.63   | )      
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|                                                    | Diluted                                            |                          | $      | 0.03                    |        |      | $       | (0.29   | )       |   | $       | (0.63   | )      
|                                                    |                                                    |                          |        |                         |        |      |         |         |         |   |         |         |        
|Weighted-average shares:                            |                                                    |                          |        |                         |        |      |         |         |         |   |         |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Basic                                              |                          |        | 75,354                  |        |      |         | 85,332  |         |   |         | 87,971  |        
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Diluted                                            |                          |        | 83,600                  |        |      |         | 85,332  |         |   |         | 87,971  |        

See accompanying notes to consolidated financial statements.

F-3



---



##### Table of Contents






QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(in thousands)

|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | ------------ | ------- | ------------ |  | ------------- | ------- | ------------- |  | -------- | ------- | ------------- |  | ------ | --- | ------------ |  | ---------- | ------- | ------------ |  | - | ------- | - |  | - | ------- | -
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  | Notes      |         | Capital      |  |   |         |  
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  | Receivable |         | Distribution |  |   |         |  
|                                                                                     |  |              |         |              |  |               |         |               |  | Retained |         | Accumulated   |  | From   |     | In Excess Of |  |            |         |             
|                                                                                     |  | Common Stock |         | Earnings     |  | Other         |         | Sale of       |  | Basis In |         | Total        
|                                                                                     |  |              |         | (Accumulated |  | Comprehensive |         | Common        |  | Common   |         | Shareholders'
|                                                                                     |  | Shares       |         | Amount       |  | Deficit)      |         | Income (Loss) |  | Stock    |         | Stock         |  | Equity
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |       
|BALANCE , January 1, 1999                                                            |  |              | 89,076  |              |  | $             | 4,241   |               |  | $        | 3,991   |               |  | $      | 0   |              |  | $          | (3,158  | )            |  | $ | 0       |   |  | $ | 5,074   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Exercise of stock options, including tax benefit of $168                             |  |              | 68      |              |  |               | 201     |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 201     |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Payment of notes receivable from shareholders for
purchase of common stock           |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            | 230     |              |  |   |        |   |  |   | 230     |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Accrued interest receivable from shareholders                                        |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            | (187    | )            |  |   |        |   |  |   | (187    | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Repurchase of common stock                                                           |  |              | (29,640 | )            |  |               | (2      | )             |  |          | (4,934  | )             |  |        |    |              |  |            |        |              |  |   | (30,064 | ) |  |   | (35,000 | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Conversion of Series A Redeemable Preferred Stock
to common stock                    |  |              | 8,000   |              |  |               | 15,000  |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 15,000  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Issuance of common stock in the initial public
offering, net                         |  |              | 10,120  |              |  |               | 64,856  |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 64,856  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Compensation expense associated with stock option
grants                             |  |              |        |              |  |               | 432     |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 432     |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Common stock issued for an acquisition                                               |  |              | 186     |              |  |               | 9,282   |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 9,282   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Dividends on Series B Redeemable Preferred Stock                                     |  |              |        |              |  |               |        |               |  |          | (590    | )             |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (590    | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Unrealized loss on available-for-sale securities                                     |  |              |        |              |  |               |        |               |  |          |        |               |  |        | (26 | )            |  |            |        |              |  |   |        |   |  |   | (26     | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Reclassification of capital distribution in excess of basis
in common stock          |  |              |        |              |  |               | (30,064 | )             |  |          |        |               |  |        |    |              |  |            |        |              |  |   | 30,064  |   |  |   |        |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Net income                                                                           |  |              |        |              |  |               |        |               |  |          | 3,397   |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 3,397   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Comprehensive income                                                                 |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 3,371   |  
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|BALANCE, December 31, 1999                                                           |  |              | 77,810  |              |  |               | 63,946  |               |  |          | 1,864   |               |  |        | (26 | )            |  |            | (3,115  | )            |  |   |        |   |  |   | 62,669  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Exercise of stock options, including tax benefit of $28,786                          |  |              | 2,493   |              |  |               | 33,151  |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 33,151  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Notes receivable and accrued interest from shareholders
for purchase of common stock |  |              | 339     |              |  |               | 15,773  |               |  |          |        |               |  |        |    |              |  |            | (15,773 | )            |  |   |        |   |  |   |        |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Repurchase of common stock                                                           |  |              | (1,718  | )            |  |               | (57,964 | )             |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (57,964 | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Issuance of common stock in the secondary public
offering, net                       |  |              | 3,808   |              |  |               | 253,469 |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 253,469 |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Common stock issued for employee stock purchase
plan                                 |  |              | 288     |              |  |               | 3,438   |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 3,438   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Compensation expense associated with stock option
grants                             |  |              |        |              |  |               | 3,441   |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 3,441   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Common stock issued for acquisitions                                                 |  |              | 3,690   |              |  |               | 185,070 |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 185,070 |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Unrealized gain on available-for-sale securities                                     |  |              |        |              |  |               |        |               |  |          |         |               |  |        | 158 |              |  |            |        |              |  |   |        |   |  |   | 158     |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Net loss                                                                             |  |              |        |              |  |               |        |               |  |          | (25,078 | )             |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (25,078 | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Comprehensive loss                                                                   |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (24,920 | )
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|BALANCE, December 31, 2000                                                           |  |              | 86,710  |              |  |               | 500,324 |               |  |          | (23,214 | )             |  |        | 132 |              |  |            | (18,888 | )            |  |   |        |   |  |   | 458,354 |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Exercise of stock options, including tax benefit of $10,370                          |  |              | 1,716   |              |  |               | 16,296  |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 16,296  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Accrued interest from shareholders for purchase of common stock                      |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            | (1,221  | )            |  |   |        |   |  |   | (1,221  | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Payments on notes receivable from shareholders for purchase of
common stock          |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            | 2,847   |              |  |   |        |   |  |   | 2,847   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Common stock issued for employee stock purchase plan                                 |  |              | 203     |              |  |               | 5,593   |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 5,593   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Compensation expense associated with stock option
grants                             |  |              |        |              |  |               | 4,508   |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 4,508   |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Common stock issued for acquisitions                                                 |  |              | 597     |              |  |               | 10,360  |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | 10,360  |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Unrealized gain on available-for-sale securities                                     |  |              |        |              |  |               |        |               |  |          |        |               |  |        | 390 |              |  |            |        |              |  |   |        |   |  |   | 390     |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Net loss                                                                             |  |              |        |              |  |               |        |               |  |          | (55,759 | )             |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (55,759 | )
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Comprehensive loss                                                                   |  |              |        |              |  |               |        |               |  |          |        |               |  |        |    |              |  |            |        |              |  |   |        |   |  |   | (55,369 | )
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  
|BALANCE, December 31, 2001                                                           |  |              | 89,226  |              |  | $             | 537,081 |               |  | $        | (78,973 | )             |  | $      | 522 |              |  | $          | (17,262 | )            |  | $ | 0       |   |  | $ | 441,368 |  
|                                                                                     |  |              |         |              |  |               |         |               |  |          |         |               |  |        |     |              |  |            |         |              |  |   |         |   |  |   |         |  

See accompanying notes to
consolidated financial statements

F-4



---



##### Table of Contents






QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|------------------------------------------------------------ | ---------------------------------------------------------------------------------------- | - | ----------------------- | ------- | ---- | - | ------- | -------- | - | - | ------ | -------- | -
|                                                             |                                                                                          |   | Year Ended December 31,
|                                                             |                                                                                          |   |                        
|                                                             |                                                                                          |   | 1999                    |         | 2000 |   | 2001   
|                                                             |                                                                                          |   |                         |         |      |   |        
|Cash flows from operating activities:                        |                                                                                          |   |                         |         |      |   |         |          |   |   |        |         
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Net income (loss)                                                                        |   | $                       | 3,397   |      |   | $       | (25,078  | ) |   | $      | (55,759  | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Adjustments to reconcile net income (loss) to net cash
provided by operating activities: |   |                         |         |      |   |         |          |   |   |        |          |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Depreciation and amortization                                                            |   |                         | 2,107   |      |   |         | 47,246   |   |   |        | 75,659   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Compensation expense associated with stock option
grants                                 |   |                         | 432     |      |   |         | 3,441    |   |   |        | 4,508    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Accrued interest receivable from shareholders                                            |   |                         | (187    | )    |   |         | (611     | ) |   |        | (1,221   | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Deferred income taxes                                                                    |   |                         | (1,667  | )    |   |         | (19,404  | ) |   |        | (5,653   | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Provision for bad debts                                                                  |   |                         | 352     |      |   |         | 457      |   |   |        | 789      |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Losses on equity investments                                                             |   |                         |        |      |   |         |         |   |   |        | 4,405    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Changes in operating assets and liabilities, net of
effects of acquisitions:             |   |                         |         |      |   |         |          |   |   |        |          |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Accounts receivable                                                                      |   |                         | (11,793 | )    |   |         | (17,841  | ) |   |        | 2,056    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Prepaid expenses and other current assets                                                |   |                         | (2,527  | )    |   |         | (6,860   | ) |   |        | 3,186    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Other assets                                                                             |   |                         | (288    | )    |   |         | (660     | ) |   |        | (34      | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Accounts payable                                                                         |   |                         | 1,974   |      |   |         | 942      |   |   |        | 18       |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Accrued compensation                                                                     |   |                         | 2,544   |      |   |         | 3,828    |   |   |        | 3,397    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Other accrued expenses                                                                   |   |                         | 5,366   |      |   |         | 4,403    |   |   |        | (752     | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Income taxes payable                                                                     |   |                         | 2,218   |      |   |         | 25,227   |   |   |        | 15,104   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Deferred revenue                                                                         |   |                         | 9,449   |      |   |         | 11,359   |   |   |        | 18,457   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Other liabilities                                                                        |   |                         |        |      |   |         | (561     | ) |   |        | 349      |  
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|                                                             | Net cash provided by operating activities                                                |   |                         | 11,377  |      |   |         | 25,888   |   |   |        | 64,509   |  
|                                                            
|                                                            
|                                                            
|                                                            
|Cash flows from investing activities:                        |                                                                                          |   |                         |         |      |   |         |          |   |   |        |         
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Purchases of property and equipment                                                      |   |                         | (7,143  | )    |   |         | (39,167  | ) |   |        | (6,166   | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Purchases of software licenses                                                           |   |                         | (350    | )    |   |         | (1,265   | ) |   |        | (15,913  | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Cash paid for acquisitions, net of cash acquired                                         |   |                         | (1,094  |      |   |         | (82,138  | ) |   |        | (330     | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Purchases of equity investments                                                          |   |                         |        |      |   |         | (8,166   | ) |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Purchases of marketable securities                                                       |   |                         | (15,510 | )    |   |         | (293,852 | ) |   |        | (187,233 | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Sales and maturities of marketable securities                                            |   |                         |        |      |   |         | 182,824  |   |   |        | 137,431  |  
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|                                                             | Net cash used in investing activities                                                    |   |                         | (24,097 | )    |   |         | (241,764 | ) |   |        | (72,211  | )
|                                                            
|                                                            
|                                                            
|                                                            
|Cash flows from financing activities:                        |                                                                                          |   |                         |         |      |   |         |          |   |   |        |         
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from note payable                                                               |   |                         | 10,000  |      |   |         |         |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Repayment of notes payable                                                               |   |                         | (10,918 | )    |   |         | (1,939   | ) |   |        | (1,163   | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Collections of Note receivable from shareholder                                          |   |                         |        |      |   |         |         |   |   |        | 2,847    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Repayment of capital lease obligations                                                   |   |                         | (36     | )    |   |         | (867     | ) |   |        | (312     | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from issuance of preferred stock                                                |   |                         | 25,000  |      |   |         |         |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Redemption of Series B Redeemable Preferred Stock                                        |   |                         | (10,000 | )    |   |         |         |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Repurchase of common stock                                                               |   |                         | (35,000 | )    |   |         | (57,353  | ) |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Net proceeds from the sale of common stock                                               |   |                         | 64,856  |      |   |         | 253,469  |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from the exercise of stock options                                              |   |                         | 33      |      |   |         | 4,365    |   |   |        | 5,926    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from employee stock purchase plan                                               |   |                         |        |      |   |         | 3,438    |   |   |        | 5,593    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Repayment of note payable to related party                                               |   |                         | (8      | )    |   |         |         |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Payment on notes receivable from shareholders for
purchase of common stock               |   |                         | 230     |      |   |         |         |   |   |        |         |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Cash dividend paid on Series B Redeemable Preferred
Stock                                |   |                         | (590    | )    |   |         |         |   |   |        |         |  
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|                                                             | Net cash provided by financing activities                                                |   |                         | 43,567  |      |   |         | 201,113  |   |   |        | 12,891   |  
|                                                            
|                                                            
|                                                            
|                                                            
|Effect of exchange rate changes on cash and cash
equivalents |                                                                                          |   | (185                    | )       |      |   | 275     |          |   |   | (65    | )       
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|Net increase (decrease) in cash and cash equivalents         |                                                                                          | $ | 30,622                  |         |      | $ | (14,488 | )        |   | $ | 5,124  |         
|                                                            
|                                                            
|                                                            
|                                                            
|Cash and cash equivalents, beginning of period               |                                                                                          |   | 8,981                   |         |      |   | 39,643  |          |   |   | 25,155 |         
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  
|Cash and cash equivalents, end of period                     |                                                                                          | $ | 39,643                  |         |      | $ | 25,155  |          |   | $ | 30,279 |         
|                                                             |                                                                                          |   |                         |         |      |   |         |          |   |   |        |          |  

See accompanying notes to
consolidated financial statements.

F-5



---



##### Table of Contents



|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |        |  
|--------------------------------------------------------------------- | ----------------------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                      |                                                                   |  | Year Ended December 31,
|                                                                      |                                                                   |  |                        
|                                                                      |                                                                   |  | 1999                    |        | 2000 |  | 2001
|                                                                      |                                                                   |  |                         |        |      |  |     
|Supplemental disclosures of consolidated cash flow
information:       |                                                                   |  |                         |        |      |  |      |        |   |  |   |       
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Cash paid for interest                                            |  | $                       | 240    |      |  | $    | 32     |   |  | $ | 103    |  
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |        |  
|                                                                      | Cash paid (received) for income taxes                             |  | $                       | 1,874  |      |  | $    | (59    | ) |  | $ | (3,642 | )
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |        |  
|Supplemental schedule of non cash investing and financing
activities: |                                                                   |  |                         |        |      |  |      |        |   |  |   |       
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Note receivable from shareholders for purchase of
common stock    |  |                         |        |      |  | $    | 15,773 |   |  |   |        |  
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |       
|                                                                      | Conversion of Series A Redeemable Preferred Stock to Common Stock |  | $                       | 15,000 |      |  |      |        |   |  |   |        |  
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |       
|                                                                      | Tax benefit related to stock option exercises                     |  | $                       | 168    |      |  | $    | 28,786 |   |  | $ | 10,370 |  
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |        |  
|                                                                      | Unrealized (loss) gain on available-for-sale securities           |  | $                       | (26    | )    |  | $    | 158    |   |  | $ | 390    |  
|                                                                      |                                                                   |  |                         |        |      |  |      |        |   |  |   |        |  

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

See accompanying notes to consolidated financial statements.

F-6



---



##### Table of Contents






QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business and Summary of Significant Accounting Policies

Nature of Operations and Basis of PresentationQuest Software, Inc., a
California corporation (the Parent) and its subsidiaries (collectively the
Company) is a leading developer and vendor of application and
database management software products. The Company also provides consulting, training, and support services
to its customers. The accompanying consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and include the accounts of the Parent and its wholly
owned subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.

Stock SplitOn March 9, 2000, the Companys Board of Directors approved
a 2-for-1 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 effect of such stock split 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.
Property, plant and equipment, cost of goods sold, and depreciation for those
operations are remeasured from foreign currencies into U.S. dollars at
historical exchange rates; other accounts are translated at current exchange
rates. 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,
1999, 2000, and 2001.

Fair Value of Financial InstrumentsThe Companys consolidated balance
sheets include the following financial instruments: cash and marketable
securities, accounts receivable, investments, accounts payable, and accrued
liabilities. The Company considers the carrying value of all financial
instruments in the consolidated financial statements to approximate fair value
because of the relatively short period of time between origination of the
instruments and their expected realization, or because they are carried at fair
value.

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), net in the accompanying
consolidated statements of operations, was $1.5 million, $13.5 million, and
$10.8 million for the years ended December 31, 1999, 2000, and 2001,
respectively.

Concentration of Credit Risk- Financial instruments that potentially
expose the Company to credit risk include cash and cash equivalents,
investments, and accounts receivable. Trade receivables potentially subject the
Company to
concentrations of credit risk. The Company closely monitors extensions of
credit and has not experienced significant credit losses in the past. The
Company maintains reserves for estimated credit losses and sales returns, and
such reserves have historically been within managements expectations. No
single customer accounted for 10% or more of total revenues or accounts
receivable in 1999, 2000, or 2001.

F-7



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

InvestmentsThe Company has classified all debt securities with
original maturities of greater than three months as available-for-sale.
Available-for-sale securities are carried at fair value, with unrealized gains
and losses reported as a separate component of shareholders equity net of
applicable income taxes. Realized gains and losses and declines in value judged
to be other-than-temporary on available-for-sale securities are included in
other income. The cost basis for realized gains and losses on
available-for-sale securities is determined on a specific identification basis.
The Company has classified available-for-sale securities as current or
long-term based primarily on the maturity date of the related securities.

The following table summarizes the Companys investments (in thousands):

|                                      |                                  |       |        |           |         |            |     |            |     |       |   |   |   |   |        |         |         | 
|------------------------------------- | -------------------------------- | ----- | ------ | --------- | ------- | ---------- | --- | ---------- | --- | ----- | - | - | - | - | ------ | ------- | ------- | 
|                                      |                                  |       |        |           |         |            |     | Gross      |     | Gross |   |   |   |  
|                                      |                                  |       |        | Amortized |         | Unrealized |     | Unrealized |     | Fair 
|December 31, 2000                     |                                  | Cost  |        | Gains     |         | Losses     |     | Value     
|                                     
|Euro
dollar bonds                     |                                  | $     | 32,904 |           |         | $          | 49  |            |     | $     |  |   |   | $ | 32,953 |        
|                                     
|                                     
|                                     
|                                     
|Asset-backed
securities (semi-annual) |                                  |       | 4,489  |           |         |            | 1   |            |     |       |  |   |   |   | 4,490  |        
|                                     
|                                     
|                                     
|                                     
|Medium
and short-term notes           |                                  |       | 12,445 |           |         |            | 26  |            |     |       |  |   |   |   | 12,471 |        
|                                     
|                                     
|                                     
|                                     
|Asset-backed
securities (monthly)     |                                  |       | 6,812  |           |         |            | 9   |            |     |       |  |   |   |   | 6,821  |        
|                                     
|                                     
|                                     
|                                     
|Corporate
bonds                       |                                  |       | 59,643 |           |         |            | 110 |            |     |       |  |   |   |   | 59,753 |        
|                                     
|                                     
|                                     
|                                     
|Commercial
paper                      |                                  |       | 5,158  |           |         |            |    |            |     |       |  |   |   |   | 5,158  |        
|                                     
|                                     
|                                     
|                                     
|U.S.
government agencies  coupon     |                                  |       | 5,000  |           |         |            | 25  |            |     |       |  |   |   |   | 5,025  |        
|                                     
|                                      |                                  | Total |        | $         | 126,451 |            |     | $          | 220 |       |   | $ |  |   |        | $       | 126,671 | 
|                                     
|Reported As:                          |                                  |       |        |           |         |            |     |            |     |       |   |   |   |   |        |        
|                                     
|                                     
|                                     
|                                     
|                                      | Short-term marketable
securities |       |        |           |         |            |     |            |     |       |   |   |   |   | $      | 8,587   |        
|                                     
|                                     
|                                     
|                                     
|                                      | Long-term marketable
securities  |       |        |           |         |            |     |            |     |       |   |   |   |   |        | 118,084 |        
|                                      |                                  |       |        |           |         |            |     |            |     |       |   |   |   |   |        |        
|                                      |                                  | Total |        |           |         |            |     |            |     |       |   |   |   |   |        | $       | 126,671 | 
|                                      |                                  |       |        |           |         |            |     |            |     |       |   |   |   |   |        |        

|                           |                                  |       |        |           |         |            |     |            |       |       |      |   |      |   |        |         |         | 
|-------------------------- | -------------------------------- | ----- | ------ | --------- | ------- | ---------- | --- | ---------- | ----- | ----- | ---- | - | ---- | - | ------ | ------- | ------- | 
|                           |                                  |       |        |           |         |            |     | Gross      |       | Gross |      |   |      |  
|                           |                                  |       |        | Amortized |         | Unrealized |     | Unrealized |       | Fair 
|December 31, 2001          |                                  | Cost  |        | Gains     |         | Losses     |     | Value     
|                          
|U.S.
government agencies   |                                  | $     | 44,920 |           |         | $          | 322 |            |       | $     | (143 | ) |      | $ | 45,098 |        
|                          
|                          
|                          
|                          
|Corporate bonds            |                                  |       | 28,125 |           |         |            | 378 |            |       |       |     |   |      |   | 28,503 |        
|                          
|                          
|                          
|                          
|Asset-backed securities    |                                  |       | 3,514  |           |         |            | 17  |            |       |       |     |   |      |   | 3,531  |        
|                          
|                          
|                          
|                          
|Mortgage-backed securities |                                  |       | 99,397 |           |         |            | 546 |            |       |       | (249 | ) |      |   | 99,694 |        
|                          
|                           |                                  | Total |        | $         | 175,956 |            |     | $          | 1,263 |       |      | $ | (393 | ) |        | $       | 176,826 | 
|                          
|Reported As:               |                                  |       |        |           |         |            |     |            |       |       |      |   |      |   |        |        
|                          
|                          
|                          
|                          
|                           | Short-term marketable
securities |       |        |           |         |            |     |            |       |       |      |   |      |   | $      | 22,723  |        
|                          
|                          
|                          
|                          
|                           | Long-term marketable
securities  |       |        |           |         |            |     |            |       |       |      |   |      |   |        | 154,103 |        
|                           |                                  |       |        |           |         |            |     |            |       |       |      |   |      |   |        |        
|                           |                                  | Total |        |           |         |            |     |            |       |       |      |   |      |   |        | $       | 176,826 | 
|                           |                                  |       |        |           |         |            |     |            |       |       |      |   |      |   |        |        

The Company also has certain other minority equity investments in non
publicly traded companies. These investments are included in other assets on
the Companys consolidated balance sheet at December 31, 2001 and are carried
at the lower of cost or fair value. The Company monitors these investments for
impairment and as a result recognized a non cash charge of $4.4 million
to write down the carrying value of certain equity investments to reflect their
estimated fair value. These investments are privately held information
technology companies, many of which are in the start-up or development stage.
These investments are carried at cost, subject to adjustment for other than
temporary impairment. The
Company determined that the decline in value in these investments was other
than temporary and recognized an impairment loss.

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 impairment to
such value has occurred. At December 31, 2000 and 2001, there was no impairment
of long-lived assets based on the Companys most recent analysis.

Property and EquipmentProperty and equipment are stated at cost less
accumulated depreciation and amortization. Maintenance and repairs are
expensed as incurred. 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

F-8



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

improvements or the term of the related lease. Repair and maintenance
costs are expensed as incurred.

Goodwill and Purchased Intangible AssetsGoodwill arising from
acquisitions (Note 2) is recorded as the excess of the purchase price over the
fair value of assets acquired and was amortized over a useful life of five
years. Accumulated goodwill amortization was $94,000, $35.2 million, and $89.5
million at December 31, 1999, 2000, and 2001, respectively. Purchased
intangible assets are recorded at the appraised value of technology, workforce,
and customer lists acquired and amortized using the straight-line method over
estimated useful lives of one to three years. Accumulated amortization of
purchased intangible assets was $5.9 million and $16.4 million at December 31,
2000 and 2001, respectively. The net carrying amount of goodwill and purchased
intangible assets was considered recoverable at December 31, 2000 and 2001,
based on the undiscounted future cash flows expected to be realized from
continued sales of the related software products. See "New Accounting
Pronouncements.

Other Assets- Other assets include software licenses, prepaid royalties,
and other long-term investments. 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, generally three years.

Revenue Recognition- The Company records revenue in accordance with FASB
Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended.

Software Licenses, Services, and Post-Contract Customer SupportThe
Company licenses its products through its direct sales force and indirectly
through resellers. Revenues from sales of software licenses, which generally do
not contain multiple elements, are recognized upon shipment and transfer of
title of the related product to the customer or reseller, 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, 2000
and 2001 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 post-contract customer support is deferred and recognized
ratably over the term of the contract. Revenue from consulting and training
services is recognized as the services are performed.

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, 2000 and 2001.

F-9



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

Other Compensation CostsThe Company records compensation expense for
options granted to purchase the Companys common stock at below fair market
value. The expense equals the difference between the fair market value of the
Companys common stock on the grant date and the exercise price of the stock
options and is recognized ratably over the vesting period of the stock options,
currently four to five years. The following table shows the allocation to Cost
of Services Revenues, Sales and Marketing, Research and Development, and
General and Administrative expenses of such costs based on the related
headcount (in thousands):

|                             |                            |  |             |         |            |  |       |       |  |  |   |         | 
|---------------------------- | -------------------------- |  | ----------- | ------- | ---------- |  | ----- | ----- |  |  | - | ------- | 
|                             |                            |  | As Reported |         | Allocation |  | Total
|                             |                            |  |             |         |            | 
|Year Ended December 31, 1999 |                            |  |             |         |            |  |       |       |  |  |   |        
|                            
|                            
|                            
|                            
|                             | Sales and marketing        |  | $           | 32,078  |            |  | $     | 389   |  |  | $ | 32,467  | 
|                            
|                            
|                            
|                            
|                             | Research and development   |  |             | 15,980  |            |  |       | 24    |  |  |   | 16,004  | 
|                            
|                            
|                            
|                            
|                             | General and administrative |  |             | 9,906   |            |  |       | 19    |  |  |   | 9,925   | 
|                            
|                            
|                            
|                            
|Year Ended December 31, 2000 |                            |  |             |         |            |  |       |       |  |  |   |        
|                            
|                            
|                            
|                            
|                             | Cost of services revenues  |  | $           | 10,695  |            |  | $     | 214   |  |  | $ | 10,909  | 
|                            
|                            
|                            
|                            
|                             | Sales and marketing        |  |             | 77,641  |            |  |       | 1,229 |  |  |   | 78,870  | 
|                            
|                            
|                            
|                            
|                             | Research and development   |  |             | 39,747  |            |  |       | 1,739 |  |  |   | 41,486  | 
|                            
|                            
|                            
|                            
|                             | General and administrative |  |             | 17,679  |            |  |       | 259   |  |  |   | 17,938  | 
|                            
|                            
|                            
|                            
|Year Ended December 31, 2001 |                            |  |             |         |            |  |       |       |  |  |   |        
|                            
|                            
|                            
|                            
|                             | Cost of services revenues  |  | $           | 17,369  |            |  | $     | 443   |  |  | $ | 17,812  | 
|                            
|                            
|                            
|                            
|                             | Sales and marketing        |  |             | 121,901 |            |  |       | 2,178 |  |  |   | 124,079 | 
|                            
|                            
|                            
|                            
|                             | Research and development   |  |             | 59,548  |            |  |       | 3,786 |  |  |   | 63,334  | 
|                            
|                            
|                            
|                            
|                             | General and administrative |  |             | 23,993  |            |  |       | 595   |  |  |   | 24,588  | 

Advertising Expenses- The Company expenses all advertising costs as
incurred, and such costs were $1.0 million, $1.8 million, and $2.8 million for
the years ended December 31, 1999, 2000, and 2001, respectively.

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

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

Net Income (Loss) Per ShareThe Company computes net income (loss) per
share in accordance with SFAS No. 128, Earnings per Share. Basic earnings
(loss) per share is computed by dividing net income (loss) available to common
shareholders by the weighted-average number of common shares outstanding for
the period. Diluted earnings (loss) 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, 2000 and 2001, all
potential common stock equivalents have been
excluded from the computation of diluted net loss per share because the
effect would be antidilutive.

F-10



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

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

|                                                      |  |                         |        |      |  |      |        |  |  |  |        | 
|----------------------------------------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------ |  |  |  | ------ | 
|                                                      |  | Year
Ended December 31,
|                                                      |  |                        
|                                                      |  | 1999                    |        | 2000 |  | 2001
|                                                      |  |                         |        |      |  |     
|Shares used in computing basic net income per share   |  |                         | 75,354 |      |  |      | 85,332 |  |  |  | 87,971 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Conversion of Series A preferred stock                |  |                         | 2,476  |      |  |      |       |  |  |  |       | 
|                                                     
|                                                     
|                                                     
|                                                     
|Dilutive effect of stock options                      |  |                         | 5,770  |      |  |      |       |  |  |  |       | 
|                                                      |  |                         |        |      |  |      |        |  |  |  |        | 
|Shares used in computing diluted net income per share |  |                         | 83,600 |      |  |      | 85,332 |  |  |  | 87,971 | 
|                                                      |  |                         |        |      |  |      |        |  |  |  |        | 

The diluted shares for the years ended December 31, 2000 and 2001 excludes
incremental shares related to stock options in the amount of 5.8 million and
4.3 million, respectively. These shares are excluded due to their antidilutive
effect as a result of the Companys loss during 2000 and 2001. There were no
antidilutive shares in 1999.

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

Comprehensive Income (Loss)The difference between net income (loss)
and comprehensive net income (loss) was an unrealized loss on
available-for-sale securities of $26,000 for the year ended December 31, 1999
and an unrealized gain on available-for-sale securities of $158,000 and
$390,000 for the years ended December 31, 2000 and 2001, respectively.

Use of EstimatesThe preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States of America 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 consolidated 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, international
expansion, ability to attract and retain qualified personnel, ability to
protect its intellectual property, and other matters inherent in the software
industry.

Reclassifications Certain prior year amounts have been reclassified in
order to conform with the current year presentation.

New Accounting Pronouncements:

In July 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires that all business combinations be
accounted for using the purchase method and provides new criteria for recording
intangible assets separately from goodwill. Existing goodwill and intangible
assets will be evaluated against these new criteria, which may result in
certain intangible assets being subsumed into goodwill. SFAS
No. 142 addresses
financial accounting and reporting for acquired goodwill and other intangible
assets. Goodwill and intangible assets that have indefinite useful lives will
not be amortized into results of operations, but instead will be evaluated at
least annually for impairment and written down when the recorded value exceeds
the estimated fair value. The Company
adopted the provisions of each statement on January 1, 2002. As a result,
the Company has ceased amortization of goodwill, reducing annual amortization
expense by

F-11



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

approximately $57.0 million. The Company is evaluating the full
impact of adopting the new standards. In addition, impairment reviews may
result in charges against earnings to write down the value of goodwill.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. SFAS No. 143 is required to be adopted
for fiscal years beginning after June 15, 2002. The Company has not yet
determined what effect this statement will have on its financial statements.

Also in August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of. This new statement also supersedes certain aspects of
Accounting Principles Board Opinion No. 30 (APB 30), Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual, and Infrequently Occurring Events and Transactions, with
regard to reporting the effects of a disposal of a segment of a business and
will require expected future operating losses from discontinued operations to
be reported in discontinued operations in the period incurred (rather than as
of the measurement date as presently required by APB 30). In addition, more
dispositions may qualify for discontinued operations treatment. The provisions
of this statement are required to be applied for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The Company
has not yet determined what effect this statement will have on its financial
statements.

2. Acquisitions

During 2000, the Company completed a total of eight acquisitions for an
aggregate purchase price of $270.3 million. The aggregate purchase price
consisted of stock valued at $182.6 million and cash of $85.3 million, and
direct acquisition costs of $2.4 million. The Company excluded from the
purchase prices the aggregate intrinsic value of unvested stock options of $5.3
million, which has been allocated to deferred compensation and will be
recognized as non cash compensation expense over the remaining future vesting
period of two and one-half years. The Company, acting as escrow agent, has
withheld an aggregate of $1.7 million in cash for indemnification obligations of
the former principal shareholders of certain of the companies acquired.

Significant acquisitions in 2000 were of Foglight Software, Inc.
(Foglight) and FastLane Technologies, Inc. (FastLane). Foglight was acquired
in exchange for 2.4 million shares of the Companys common stock valued at
$101.8 million, cash payments of approximately $500,000 (including $400,000 in
direct acquisition costs), and the assumption of unvested Foglight stock
options valued at $2.2 million. FastLane was acquired in exchange for 1.1
million shares of the Companys common stock valued at $63.1 million, cash
payments of $34.1 million (including $600,000 in direct acquisition costs), and
the assumption of FastLane stock options valued at $7.3 million (excluding
intrinsic value of unvested options of $5.3 million).

During 2001, the Company acquired the outstanding shares of RevealNet,
Inc. and substantially all of the assets of Laminar Software, Inc. for an
aggregate purchase price of $10.1 million and $2.2 million, respectively. The
purchase price for RevealNet, Inc. consisted of stock valued at $10 million and
direct acquisition costs of $106,000. The purchase price for Laminar Software,
Inc. consisted of stock valued at $1.7 million, cash of
$152,000, forgiveness of previous cash advances of $252,000, and
direct acquisition costs of $40,000.

The acquisitions in 2000 and 2001 were accounted as purchase business
combinations, and the results of each acquisitions operations are included in
the Companys consolidated statements of operations from the date of
acquisition. The purchase prices of these acquisitions were allocated as
follows (in thousands):

F-12



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##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   |         |         | 
|---------------------------------------------------- | --------------------------- | - | ------- | ----- | ------------ |  | -------- | ----- | ----------- |  | ----------- | ------- | ------- |  | -------- | ------ | -------- |  | ------- | ------- | - |  | ------ | ------ | - | - | ------- | ------- | 
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   | Total  
|                                                     |                             |   | Current |       | Fixed Assets |  |          |       |             |  | Other       |         | Assumed |  | Deferred |        | Purchase
|                                                     |                             |   | Assets  |       | and Other    |  | Goodwill |       | Intangibles |  | Liabilities |         | Taxes   |  | Price   
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |         
|YEAR ENDED DECEMBER 31, 2000
Foglight Software, Inc. |                             | $ | 637     |       |              |  | 893      |       |             |  | 99,285      |         |         |  | 5,860    |        |          |  | (5,728  | )       |   |  | 3,542  |        |   | $ | 104,489 |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | FastLane Technologies, Inc. |   |         | 3,781 |              |  |          | 1,672 |             |  |             | 102,673 |         |  |          | 12,477 |          |  |         | (10,639 | ) |  |        | (5,469 | ) |   |         | 104,495 | 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Others                      |   |         | 2,733 |              |  |          | 377   |             |  |             | 58,065  |         |  |          | 7,067  |          |  |         | (4,345  | ) |  |        | (2,546 | ) |   |         | 61,351  | 
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   |         |        
|                                                     |                             | $ | 7,151   |       |              |  | 2,942    |       |             |  | 260,023     |         |         |  | 25,404   |        |          |  | (20,712 | )       |   |  | (4,473 | )      |   | $ | 270,335 |        
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   |         |        
|YEAR ENDED DECEMBER 31, 2001
RevealNet, Inc.         |                             | $ | 714     |       |              |  | 19       |       |             |  | 7,330       |         |         |  | 3,190    |        |          |  | (674    | )       |   |  | (436   | )      |   | $ | 10,143  |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Laminar Software, Inc.      |   |         |      |              |  |          | 114   |             |  |             | 2,200   |         |  |          |       |          |  |         | (129    | ) |  |        |       |   |   |         | 2,185   | 
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   |         |        
|                                                     |                             | $ | 714     |       |              |  | 133      |       |             |  | 9,530       |         |         |  | 3,190    |        |          |  | (803    | )       |   |  | (436   | )      |   | $ | 12,328  |        
|                                                     |                             |   |         |       |              |  |          |       |             |  |             |         |         |  |          |        |          |  |         |         |   |  |        |        |   |   |         |        

The Companys financial results for the years ended December 31, 2000 and
2001 include actual results of these acquisitions for the period following
dates acquisitions were made. The pro forma results of operations data, 2000
and 2001 presented below assume that the acquisitions had been made at the
beginning of each fiscal year, and include amortization of goodwill and
identified intangibles from that date. The pro forma data is presented for
informational purposes only and is not necessarily indicative of the results of
future operations nor of the actual results that would have been achieved had
the acquisitions taken place at the beginning of the fiscal year (in
thousands):

|                                       |  |                                  |         |      |  |   |         |  
|-------------------------------------- |  | -------------------------------- | ------- | ---- |  | - | ------- | -
|                                       |  | Twelve Months Ended December 31,
|                                       |  |                                 
|                                       |  | 2000                             |         | 2001
|                                       |  |                                  |         |     
|Revenues                               |  | $                                | 177,503 |      |  | $ | 246,788 |  
|                                      
|                                      
|                                      
|                                      
|Net loss                               |  |                                  | (56,972 | )    |  |   | (56,260 | )
|                                      
|                                      
|                                      
|                                      
|Net loss per share  basic and diluted |  |                                  | (0.66   | )    |  |   | (0.64   | )

3. Property and Equipment

Net property and equipment consist of the following at December 31 (in
thousands):

|                                               |  |      |        |      |  |   |         |  
|---------------------------------------------- |  | ---- | ------ | ---- |  | - | ------- | -
|                                               |  | 2000 |        | 2001
|                                               |  |      |        |     
|Furniture and fixtures                         |  | $    | 6,911  |      |  | $ | 7,688   |  
|                                              
|                                              
|                                              
|                                              
|Machinery and equipment                        |  |      | 26,576 |      |  |   | 27,490  |  
|                                              
|                                              
|                                              
|                                              
|Computer equipment                             |  |      | 15,085 |      |  |   | 19,000  |  
|                                              
|                                              
|                                              
|                                              
|Computer software                              |  |      | 3,823  |      |  |   | 18,693  |  
|                                              
|                                              
|                                              
|                                              
|Leasehold improvements                         |  |      | 2,161  |      |  |   | 3,465   |  
|                                               |  |      |        |      |  |   |         |  
|                                               |  |      | 54,556 |      |  |   | 76,336  |  
|                                              
|                                              
|                                              
|                                              
|Less accumulated depreciation and amortization |  |      | (7,716 | )    |  |   | (18,840 | )
|                                               |  |      |        |      |  |   |         |  
|Property and equipment, net                    |  | $    | 46,840 |      |  | $ | 57,496  |  
|                                               |  |      |        |      |  |   |         |  

4. Related-Party Transactions

During 1997, the Company received a note receivable from an officer of the
Company for the purchase of 7.8 million shares of the Companys common stock at
$0.28 per share. The note receivable, plus accrued interest, was due April 2002
bearing interest at 6.2%. The note receivable and accrued interest was secured
by the common stock. In December 2001, the officer repaid the note receivable,
plus accrued interest, in full.

F-13



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

During 1998, the Company received a note receivable from another officer
of the Company for the purchase of 1.9 million shares of the Companys common
stock at $0.39 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 canceled 29.6 million shares of
common stock from a shareholder of the Company at a price of $1.18 per share.
The Company also entered into a severance agreement with the shareholder
whereby the shareholder will receive $200,000 per year through 2002 and
provides for use of a company car and related expenses and medical benefits.
The Company recorded approximately $700,000 of expense related to the agreement
in April 1999, which is included in compensation and other costs in the
accompanying consolidated financial statements.

In August 2000, the Company received a note receivable from an officer of
the Company for the purchase of 339,000 shares of the Companys common stock at
$46.50 per share. The note receivable, plus accrued interest, is due August
2007 and bears interest at 6.33% per annum. The note receivable and accrued
interest are secured by the common stock and are deemed fully collectible at
December 31, 2001.

5. Long-Term Debt

In conjunction with an acquisition, the Company assumed a $4.4 million
zero-interest loan related to a research and development funding arrangement
with the Province of Nova Scotia. The Company has imputed interest on the loan
of $1.2 million, which will be amortized to interest expense over the term of
the loan. The repayments have been fixed at $1.2 million each
July of 2001,
2002, and 2003, with the balance repayable in 2004.

6. Income Taxes

The provision for income taxes consists of the following for the years ended
December 31 (in thousands):

|          |                               |                            |        |        |       |      |         |         |       |  |        |        |       | 
|--------- | ----------------------------- | -------------------------- | ------ | ------ | ----- | ---- | ------- | ------- | ----- |  | ------ | ------ | ----- | 
|          |                               |                            |        | 1999   |       | 2000 |         | 2001   
|          |                               |                            |        |        |       |      |         |        
|Current:  |                               |                            |        |        |       |      |         |         |       |  |        |       
|         
|         
|         
|         
|          | Federal                       |                            | $      | 2,763  |       |      | $       | 21,434  |       |  | $      | 9,743  |      
|         
|         
|         
|         
|          | State                         |                            |        | 402    |       |      |         | 4,516   |       |  |        | 1,557  |      
|         
|         
|         
|         
|          | Foreign                       |                            |        | 808    |       |      |         | 109     |       |  |        | 149    |      
|          |                               |                            |        |        |       |      |         |         |       |  |        |       
|          |                               |                            | 3,973  |        |       |      | 26,059  |         |       |  | 11,449 |       
|         
|         
|         
|         
|Deferred: |                               |                            |        |        |       |      |         |         |       |  |        |       
|         
|         
|         
|         
|          | Federal                       |                            |        | (1,391 | )     |      |         | (15,080 | )     |  |        | (4,083 | )    
|         
|         
|         
|         
|          | State                         |                            |        | (309   | )     |      |         | (4,277  | )     |  |        | (3,352 | )    
|         
|         
|         
|         
|          | Foreign                       |                            |        | (122   | )     |      |         | 103     |       |  |        | (4,646 | )    
|         
|         
|         
|         
|          | Change in valuation allowance |                            |        | 122    |       |      |         |        |       |  |        | 6,493  |      
|          |                               |                            |        |        |       |      |         |         |       |  |        |       
|          |                               |                            | (1,700 | )      |       |      | (19,254 | )       |       |  | (5,588 | )     
|          |                               |                            |        |        |       |      |         |         |       |  |        |       
|          |                               | Total income tax provision |        | $      | 2,273 |      |         | $       | 6,805 |  |        | $      | 5,861 | 
|          |                               |                            |        |        |       |      |         |         |       |  |        |       

F-14



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

The reconciliation of the U.S. federal statutory rate to the effective income
tax rate for the years ended December 31, 1999, 2000, and 2001, is as follows:

|                                                        |  |      |      |      |  |      |       |    |  |  |       |   
|------------------------------------------------------- |  | ---- | ---- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                        |  | 1999 |      | 2000 |  | 2001
|                                                        |  |      |      |      |  |     
|Tax provision (benefit) at U.S. federal statutory rates |  |      | 35.0 | %    |  |      | (35.0 | )% |  |  | (35.0 | )%
|                                                       
|                                                       
|                                                       
|                                                       
|State taxes                                             |  |      | 1.1  |      |  |      | 0.8   |    |  |  | (1.9  | ) 
|Amortization                                            |  |      | 0.6  |      |  |      | 67.6  |    |  |  | 38.1  |   
|                                                       
|                                                       
|                                                       
|                                                       
|Foreign taxes and foreign losses without tax benefit    |  |      | 8.3  |      |  |      | 8.1   |    |  |  | 13.5  |   
|                                                       
|                                                       
|                                                       
|                                                       
|Research and development credits                        |  |      | (4.7 | )    |  |      | (5.6  | )  |  |  | (5.8  | ) 
|                                                       
|                                                       
|                                                       
|                                                       
|Other                                                   |  |      | (0.2 | )    |  |      | 1.3   |    |  |  | 2.9   |   
|                                                        |  |      |      |      |  |      |       |    |  |  |       |   
|                                                        |  |      | 40.1 | %    |  |      | 37.2  | %  |  |  | 11.8  | % 
|                                                        |  |      |      |      |  |      |       |    |  |  |       |   

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, 2000 and 2001 are as follows
(in thousands):

|                                 |                                                |   |         |        |      |   |         |        |  
|-------------------------------- | ---------------------------------------------- | - | ------- | ------ | ---- | - | ------- | ------ | -
|                                 |                                                |   | 2000    |        | 2001
|                                 |                                                |   |         |        |     
|Deferred tax assets:             |                                                |   |         |        |      |   |         |       
|                                
|                                
|                                
|                                
|                                 | Accounts receivable and sales returns reserves |   | $       | 1,709  |      |   | $       | 1,435  |  
|                                
|                                
|                                
|                                
|                                 | Accrued liabilities                            |   |         | 1,884  |      |   |         | 3,125  |  
|                                
|                                
|                                
|                                
|                                 | Foreign net operating loss carryforwards       |   |         | 10,136 |      |   |         | 15,050 |  
|                                
|                                
|                                
|                                
|                                 | U.S. net operating loss carryforwards          |   |         | 9,330  |      |   |         | 18,895 |  
|                                
|                                
|                                
|                                
|                                 | Stock compensation                             |   |         | 1,655  |      |   |         | 1,189  |  
|                                
|                                
|                                
|                                
|                                 | Tax credits                                    |   |         | 5,306  |      |   |         | 10,511 |  
|                                
|                                
|                                
|                                
|                                 | Deferred revenue                               |   |         | 11,313 |      |   |         | 9,677  |  
|                                
|                                
|                                
|                                
|                                 | Other                                          |   |         | 313    |      |   |         | 2,543  |  
|                                 |                                                |   |         |        |      |   |         |       
|Total gross deferred assets      |                                                |   | 41,646  |        |      |   | 62,425  |       
|                                
|                                
|                                
|                                
|Deferred tax liabilities:        |                                                |   |         |        |      |   |         |       
|                                
|                                
|                                
|                                
|                                 | Intangibles                                    |   |         | (7,853 | )    |   |         | (3,191 | )
|                                
|                                
|                                
|                                
|                                 | State taxes                                    |   |         | (1,961 | )    |   |         | (3,905 | )
|                                
|                                
|                                
|                                
|                                 | Fixed assets                                   |   |         | (323   | )    |   |         | (2,611 | )
|                                 |                                                |   |         |        |      |   |         |       
|Total gross deferred liabilities |                                                |   | (10,137 | )      |      |   | (9,707  | )     
|                                
|                                
|                                
|                                
|Valuation allowance              |                                                |   | (13,675 | )      |      |   | (29,731 | )     
|                                 |                                                |   |         |        |      |   |         |       
|Net deferred income taxes        |                                                | $ | 17,834  |        |      | $ | 22,987  |       
|                                 |                                                |   |         |        |      |   |         |       
|Less current portion             |                                                |   | (14,833 | )      |      |   | (12,085 | )     
|                                 |                                                |   |         |        |      |   |         |       
|                                 |                                                | $ | 3,001   |        |      | $ | 10,902  |       
|                                 |                                                |   |         |        |      |   |         |       

At December 31, 2001, the Company has recorded a valuation allowance of
$29.7 million on its deferred tax assets. Based on the weight of available
evidence, the Company believes that it is more likely than not that these
deferred tax assets will not be realized. Approximately $9.5 million of the
change in the valuation allowance relates to net operating losses from stock
option exercises. If these deferred tax assets are realized in the future, the
tax benefit will be credited to shareholders equity.

At December 31, 2001 the Company has federal, state, and foreign net
operating loss carryforwards of $38.7 million, $66.9 million, and $36.4 million
which begin to expire in 2018, 2005, and 2002, respectively. Approximately
$12.7 million of the federal and $12.8 million of the state net operating loss
carryforwards relate to acquired companies and are subject to limitations on
their utilization.

At December 31, 2001 the Company had federal and state tax credit
carryforwards of $6.2 million and $4.3 million, respectively, which begin to
expire in 2018.

Tax benefits associated with the exercise of stock options of $28.8
million and $10.3 million in 2000 and 2001, respectively were credited to
shareholders equity.

F-15



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

Income (loss) before income taxes consists of the following
components (in thousands):



|              |  |      |       |      |  |      |          |  |  |   |          | 
|------------- |  | ---- | ----- | ---- |  | ---- | -------- |  |  | - | -------- | 
|              |  | 1999 |       | 2000 |  | 2001
|              |  |      |       |      |  |     
|United
States |  | $    | 4,547 |      |  | $    | (1,440)  |  |  | $ | (4,039)  | 
|             
|             
|             
|             
|Foreign       |  |      | 1,123 |      |  |      | (16,833) |  |  |   | (45,859) | 
|              |  |      |       |      |  |      |          |  |  |   |         
|Total         |  | $    | 5,670 |      |  | $    | (18,273) |  |  | $ | (49,898) | 
|              |  |      |       |      |  |      |          |  |  |   |         

Undistributed earnings of the Companys foreign subsidiaries were
immaterial as of December 31, 2001. Those earnings are considered to be
permanently reinvested. Accordingly, no provision for U.S. federal or state income
tax has been provided thereon.

7. Shareholders Equity

In April 1999, the Company issued 2.7 million shares of Series A preferred
stock for $15.0 million, and 1.8 million shares of Series B redeemable
preferred stock for $10.0 million. In connection with the Companys initial
public offering in August 1999, all outstanding shares of Series A preferred
stock were converted into 8.0 million shares of common stock and all
outstanding shares of the Series B redeemable preferred stock shares were
redeemed for $10.0 million, plus dividends of $590,000.

In August 1999, the Company completed an initial public offering of 8.8
million shares of its common stock. The Company received net proceeds of $64.9
million after deducting underwriting and offering expenses.

In March 2000, the Company and certain selling shareholders sold 8.4
million shares of its common stock as part of a secondary offering. Of the
shares sold in the offering, 3.8 million shares were sold by the Company and
4.6 million shares were sold by selling shareholders. The Companys net
proceeds from its sale of stock were $253.5 million, after underwriting and
offering expenses. The Company did not receive any proceeds from the shares
sold by selling shareholders.

In December 2000, the Board of Directors authorized a stock repurchase
program under which the Company may purchase up to 2 million shares of its
common stock. Under the repurchase program, the Company may purchase shares
from time to time at varying prices in open market or private transactions. The
Company did not set any timeline within which repurchases would be made and has
not committed to repurchase any specific amount of shares. As of December 31,
2000, the Company had repurchased 1.7 million shares for approximately $57.4
million. During 2000, the Company also repurchased approximately 1,000 shares
issued to former shareholders of an acquisition for approximately $600,000. All
shares repurchased have been cancelled and returned to the status of authorized
and unissued.

In October 2001, the Board of Directors increased the total number of
shares authorized for repurchase under the Companys stock repurchase program
from 2 million shares to 5 million. No additional shares were repurchased in
2001.

8. Employee Benefit Plans

Stock Option Plans

The Companys stock option plans provide for the issuance of stock options
to employees, directors, and consultants of the Company. The options are
generally granted at the fair market value of the Companys common stock at the
grant date, expire ten years from the date of grant, and ratably vest over a
four- to five-year period. As of December 31, 2001, the Company has authorized
22.8 million shares for issuance under the plans, of which 3.0 million shares are
available for future grant.

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. Had compensation cost been determined using the provisions of
SFAS No. 123, the Companys net income (loss) available to common shareholders
would have been adjusted to the pro forma amounts indicated below (in
thousands, except per share data):

F-16



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

|                                                     |             |  |              |       |      |  |      |         |   |  |   |         |  
|---------------------------------------------------- | ----------- |  | ------------ | ----- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                     |             |  | December 31,
|                                                     |             |  |             
|                                                     |             |  | 1999         |       | 2000 |  | 2001
|                                                     |             |  |              |       |      |  |     
|Net income (loss) applicable to common shareholders: |             |  |              |       |      |  |      |         |   |  |   |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | As reported |  | $            | 2,807 |      |  | $    | (25,078 | ) |  | $ | (55,759 | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        
|                                                     | Pro forma   |  | $            | 202   |      |  | $    | (47,691 | ) |  | $ | (91,318 | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        
|Basic net income (loss) per share:                   |             |  |              |       |      |  |      |         |   |  |   |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | As reported |  | $            | 0.04  |      |  | $    | (0.29   | ) |  | $ | (0.63   | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        
|                                                     | Pro forma   |  | $            |      |      |  | $    | (0.56   | ) |  | $ | (1.04   | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        
|Diluted net income (loss) per share:                 |             |  |              |       |      |  |      |         |   |  |   |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | As reported |  | $            | 0.03  |      |  | $    | (0.29   | ) |  | $ | (0.63   | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        
|                                                     | Pro forma   |  | $            |      |      |  | $    | (0.56   | ) |  | $ | (1.04   | )
|                                                     |             |  |              |       |      |  |      |         |   |  |   |        

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.
Weighted-average assumptions used for 1999 were: expected volatility of 221%;
risk-free interest rates of 6%; and expected lives of five years.
Weighted-average assumptions for 2000 were: expected volatility of 122%; risk-free
interest rates of 6%; and expected lives of five years. Weighted-average
assumptions for 2001 were: expected volatility of 103%; risk-free interest
rates of 5%; and expected lives of five years.

A summary of the status of the Companys stock option plans as of December
31, 1999, 2000, and 2001, and changes during the years ending on those dates is
presented below (in thousands, except per share data):

|                                                               |  |        |        |          |  |           |      |          |  |        |        |           |  |          |       |  |  |           |        |   |  |   |       | 
|-------------------------------------------------------------- |  | ------ | ------ | -------- |  | --------- | ---- | -------- |  | ------ | ------ | --------- |  | -------- | ----- |  |  | --------- | ------ | - |  | - | ----- | 
|                                                               |  | 1999   |        | 2000     |  | 2001     
|                                                               |  |        |        |          |  |          
|                                                               |  |        |        |          |  | Weighted- |      |          |  |        |        | Weighted- |  |          |       |  |  | Weighted-
|                                                               |  |        |        |          |  | Average   |      |          |  |        |        | Average   |  |          |       |  |  | Average  
|                                                               |  |        |        | Exercise |  |           |      | Exercise |  |        |        |           |  | Exercise
|                                                               |  | Shares |        | Price    |  | Shares    |      | Price    |  | Shares |        | Price    
|                                                               |  |        |        |          |  |           |      |          |  |        |        |          
|Outstanding, beginning of period                               |  |        | 6,734  |          |  | $         | 0.60 |          |  |        | 10,512 |           |  | $        | 3.44  |  |  |           | 10,641 |   |  | $ | 12.56 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Granted                                                        |  |        | 4,782  |          |  | $         | 7.03 |          |  |        | 4,142  |           |  | $        | 29.42 |  |  |           | 8,895  |   |  | $ | 14.16 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Exercised                                                      |  |        | (68    | )        |  | $         | .50  |          |  |        | (2,493 | )         |  | $        | 1.81  |  |  |           | (1,716 | ) |  | $ | 3.76  | 
|                                                              
|                                                              
|                                                              
|                                                              
|Canceled                                                       |  |        | (936   | )        |  | $         | 1.60 |          |  |        | (1,520 | )         |  | $        | 13.03 |  |  |           | (2,252 | ) |  | $ | 19.08 | 
|                                                               |  |        |        |          |  |           |      |          |  |        |        |           |  |          |       |  |  |           |        |   |  |   |       | 
|Balance, end of period                                         |  |        | 10,512 |          |  | $         | 3.44 |          |  |        | 10,641 |           |  | $        | 12.56 |  |  |           | 15,568 |   |  | $ | 13.56 | 
|                                                               |  |        |        |          |  |           |      |          |  |        |        |           |  |          |       |  |  |           |        |   |  |   |       | 
|Exercisable, end of period                                     |  |        | 1,406  |          |  | $         | 1.03 |          |  |        | 1,684  |           |  | $        | 4.13  |  |  |           | 2,922  |   |  | $ | 8.82  | 
|                                                               |  |        |        |          |  |           |      |          |  |        |        |           |  |          |       |  |  |           |        |   |  |   |       | 
|Weighted-average fair value of options
granted during the year |  |        |        |          |  | $         | 6.71 |          |  |        |        |           |  | $        | 30.90 |  |  |           |        |   |  | $ | 14.16 | 
|                                                               |  |        |        |          |  |           |      |          |  |        |        |           |  |          |       |  |  |           |        |   |  |   |       | 

During
1999, options to purchase an aggregate of 1.5 million shares, with a
weighted-average exercise price of $6.65 per share, were granted with
below market exercise prices. During 2000, options to purchase an
aggregate of 594,000 shares, with a weighted-average exercise price
of $26.84 per share, were granted with below market exercise prices.
No options were granted during 2001 with below market exercise
prices. Included in
compensation and other costs in the accompanying consolidated financial
statements is $3.4 million and $4.5 million of expense recorded during the
years ended December 31, 2000 and 2001, respectively, associated with such
option grants. Future costs of these grants will be approximately $3.5 million
in 2002 and $1.7 million, thereafter. The expense equals the difference between
the fair market value of the

F-17



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

Companys common stock on the grant date and the exercise price of the stock
options and is recognized ratably over the vesting period of the stock options,
currently four to five years.

The following tables summarizes information about stock options outstanding at
December 31, 2001 (numbers of shares in thousands):

|                |  |                     |        |                     |  |                |      |             |  |                |       |  |  |           |       |  |  |   |       | 
|--------------- |  | ------------------- | ------ | ------------------- |  | -------------- | ---- | ----------- |  | -------------- | ----- |  |  | --------- | ----- |  |  | - | ----- | 
|                |  | Options Outstanding |        | Options Exercisable
|                |  |                     |        |                    
|                |  |                     |        |                     |  | Weighted-      |      |             |  |                |       |  |  |           |       |  |  |  
|                |  |                     |        |                     |  | Average        |      | Weighted-   |  |                |       |  |  | Weighted-
|Range of        |  | Number              |        | Remaining           |  | Average        |      | Number      |  | Average       
|Exercise Prices |  | Outstanding         |        | Contractual Life    |  | Exercise Price |      | Exercisable |  | Exercise Price
|                |  |                     |        |                     |  |                |      |             |  |               
|$0.50 - 0.50    |  |                     | 1,955  |                     |  |                | 6.49 |             |  | $              | 0.50  |  |  |           | 1,278 |  |  | $ | 0.50  | 
|               
|               
|               
|               
|$0.59 - 1.89    |  |                     | 1,699  |                     |  |                | 7.05 |             |  | $              | 1.24  |  |  |           | 705   |  |  | $ | 1.14  | 
|               
|               
|               
|               
|$3.00  10.46   |  |                     | 849    |                     |  |                | 8.51 |             |  | $              | 7.29  |  |  |           | 132   |  |  | $ | 5.05  | 
|               
|               
|               
|               
|$10.74  10.74  |  |                     | 3,265  |                     |  |                | 9.75 |             |  | $              | 10.74 |  |  |           |      |  |  |   |      | 
|               
|               
|               
|               
|$12.92  12.92  |  |                     | 3      |                     |  |                | 1.49 |             |  | $              | 12.92 |  |  |           | 2     |  |  | $ | 12.92 | 
|               
|               
|               
|               
|$14.81  14.81  |  |                     | 1,368  |                     |  |                | 9.26 |             |  | $              | 14.81 |  |  |           |      |  |  |   |      | 
|               
|               
|               
|               
|$15.13  15.13  |  |                     | 2,515  |                     |  |                | 9.24 |             |  | $              | 15.13 |  |  |           |      |  |  |   |      | 
|               
|               
|               
|               
|$15.13  25.38  |  |                     | 1,434  |                     |  |                | 8.83 |             |  | $              | 22.33 |  |  |           | 171   |  |  | $ | 22.01 | 
|               
|               
|               
|               
|$26.50  26.50  |  |                     | 1,602  |                     |  |                | 8.28 |             |  | $              | 26.50 |  |  |           | 349   |  |  | $ | 26.50 | 
|               
|               
|               
|               
|$27.00
 53.41  |  |                     | 878    |                     |  |                | 8.43 |             |  | $              | 38.52 |  |  |           | 285   |  |  | $ | 37.34 | 
|                |  |                     |        |                     |  |                |      |             |  |                |       |  |  |           |       |  |  |   |       | 
|                |  |                     | 15,568 |                     |  |                |      |             |  | $              | 13.56 |  |  |           | 2,922 |  |  | $ | 8.82  | 
|                |  |                     |        |                     |  |                |      |             |  |                |       |  |  |           |       |  |  |   |       | 

Employee Stock Purchase Plan

Under the Companys 1999 Employee Stock Purchase Plan, the Company is
authorized to issue up to 1.2 million shares of common stock to eligible
employees and the employees of participating subsidiaries. Individuals who are
scheduled to work more than 20 hours per week for more than five calendar
months per year are eligible to participate in the plan. 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 semi-annual purchase
dates. The purchase price per share will be equal to 85% of the fair market
value of the common stock on the start date of the purchase period or, if
lower, the fair market value on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of January and July each
year.

At December 31, 2001, 708,000 shares of common stock were reserved for
issuance. In January 2001, 94,000 shares of common stock were purchased under
the Companys Employee Stock Purchase Plan at a price of $31.82 per share. In
July 2001, 109,000 shares of common stock were purchased under the Companys
Employee Stock Purchase Plan at a price of $23.86 per share. At December 31,
2001, $2.4 million was recorded in accrued liabilities that employees had
deposited for purchases of common stock under the plan for the current offering
period, which expired on January 31, 2002.

Employee 401(k) Plan

The Company sponsors the Quest Software, Inc. 401(k) Plan (the Plan)
covering substantially all employees. As allowed under Section 401(k) of the
Internal Revenue Code, the Plan provides tax-deferred salary deductions for
eligible employees. Employees may contribute from 1% to 15% of their annual
compensation to the Plan, limited to a maximum annual amount as set
periodically by the Internal Revenue Service. The Plan provides for
discretionary contributions, as determined by the Board of Directors. Such
contributions to the Plan are allocated among eligible participants in the
proportion of their salaries to the total salaries of all participants.
Participant contributions vest immediately. Discretionary contributions made
by the Company vest over a three-year period. The Companys discretionary
contributions to the Plan totaled $929,000, $1.0 million, and $988,000 for the
years ended December 31, 1999, 2000, and 2001, respectively.

F-18



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

9. Commitments and Contingencies

The Company leases its office facilities and certain equipment under
various operating leases. A majority of these leases are non-cancelable and
obligate the Company to pay costs of maintenance, utilities, and applicable
taxes. The leases on most of the office facilities contain escalation clauses
and renewal options. Total rent expense was $2.6 million,
$6.5 million, and
$12.2 million for the years ending December 31, 1999, 2000, and 2001,
respectively.

Minimum lease commitments under non-cancelable operating leases as of
December 31, 2001 are as follows (in thousands):

|                         |  |   |        | 
|------------------------ |  | - | ------ | 
|Year ending December 31: |  |   |        | 
|                        
|                        
|                        
|                        
|2002                     |  | $ | 11,501 | 
|                        
|                        
|                        
|                        
|2003                     |  |   | 9,820  | 
|                        
|                        
|                        
|                        
|2004                     |  |   | 7,607  | 
|                        
|                        
|                        
|                        
|2005                     |  |   | 6,186  | 
|                        
|                        
|                        
|                        
|2006                     |  |   | 2,748  | 
|                        
|                        
|                        
|                        
|Thereafter               |  |   | 844    | 
|                         |  |   |        | 
|                         |  | $ | 38,706 | 
|                         |  |   |        | 

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 and Segment Information

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

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

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

Reportable
segment data for the three years in the period ended
December 31, 2001, is as follows (in thousands):

F-19



---



##### Table of Contents



QUEST SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

|                              |                  |              |   |          |         |          |   |        |        |  |   |         |         | 
|----------------------------- | ---------------- | ------------ | - | -------- | ------- | -------- | - | ------ | ------ |  | - | ------- | ------- | 
|                              |                  |              |   | Licenses |         | Services |   | Total 
|                              |                  |              |   |          |         |          |   |       
|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  | 
|                              |                  |              |   |          |         |          |   |        |        |  |   |        
|Year ended December 31, 2000: |                  |              |   |          |         |          |   |        |        |  |   |        
|                             
|                             
|                             
|                             
|                              | Revenues         |              | $ | 126,767  |         |          | $ | 38,820 |        |  | $ | 165,587 |        
|                             
|                             
|                             
|                             
|                              | Cost of revenues |              |   | 8,609    |         |          |   | 10,695 |        |  |   | 19,304  |        
|                              |                  |              |   |          |         |          |   |        |        |  |   |        
|                              |                  | Gross profit |   | $        | 118,158 |          |   | $      | 28,125 |  |   | $       | 146,283 | 
|                              |                  |              |   |          |         |          |   |        |        |  |   |        
|Year ended December 31, 2001: |                  |              |   |          |         |          |   |        |        |  |   |        
|                             
|                             
|                             
|                             
|                              | Revenues         |              | $ | 174,134  |         |          | $ | 71,216 |        |  | $ | 245,350 |        
|                             
|                             
|                             
|                             
|                              | Cost of revenues |              |   | 12,513   |         |          |   | 17,369 |        |  |   | 29,882  |        
|                              |                  |              |   |          |         |          |   |        |        |  |   |        
|                              |                  | Gross profit |   | $        | 161,621 |          |   | $      | 53,847 |  |   | $       | 215,468 | 
|                              |                  |              |   |          |         |          |   |        |        |  |   |        

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 (in thousands):

|                              |                               |  |             |         |        |  |               |        |       |  |   |        |   |  |   |         |  
|----------------------------- | ----------------------------- |  | ----------- | ------- | ------ |  | ------------- | ------ | ----- |  | - | ------ | - |  | - | ------- | -
|                              |                               |  | North       |         |        |  |               |        | Other |  |   |        |  
|                              |                               |  | America (1) |         | Europe |  | International |        | Total
|                              |                               |  |             |         |        |  |               |        |      
|Year ended December 31, 1999: |                               |  |             |         |        |  |               |        |       |  |   |        |   |  |   |        
|                             
|                             
|                             
|                             
|                              | Revenues                      |  | $           | 55,532  |        |  | $             | 13,213 |       |  | $ | 2,123  |   |  | $ | 70,868  |  
|                             
|                             
|                             
|                             
|                              | Gross profit                  |  |             | 55,389  |        |  |               | 6,862  |       |  |   | 1,424  |   |  |   | 63,675  |  
|                             
|                             
|                             
|                             
|                              | Income from operations        |  |             | 3,270   |        |  |               | 498    |       |  |   | 700    |   |  |   | 4,468   |  
|                             
|                             
|                             
|                             
|                              | Long-lived assets             |  |             | 17,682  |        |  |               | 411    |       |  |   | 538    |   |  |   | 18,631  |  
|                             
|                             
|                             
|                             
|Year ended December 31, 2000: |                               |  |             |         |        |  |               |        |       |  |   |        |   |  |   |        
|                             
|                             
|                             
|                             
|                              | Revenues                      |  | $           | 136,847 |        |  | $             | 25,901 |       |  | $ | 2,839  |   |  | $ | 165,587 |  
|                             
|                             
|                             
|                             
|                              | Gross profit                  |  |             | 131,363 |        |  |               | 13,732 |       |  |   | 1,189  |   |  |   | 146,283 |  
|                             
|                             
|                             
|                             
|                              | Income (loss) from operations |  |             | (27,447 | )      |  |               | (142   | )     |  |   | (2,287 | ) |  |   | (29,876 | )
|                             
|                             
|                             
|                             
|                              | Long-lived assets             |  |             | 300,136 |        |  |               | 1,202  |       |  |   | 1,360  |   |  |   | 302,698 |  
|                             
|                             
|                             
|                             
|Year ended December 31, 2001: |                               |  |             |         |        |  |               |        |       |  |   |        |   |  |   |        
|                             
|                             
|                             
|                             
|                              | Revenues                      |  | $           | 196,981 |        |  | $             | 42,534 |       |  | $ | 5,835  |   |  | $ | 245,350 |  
|                             
|                             
|                             
|                             
|                              | Gross profit                  |  |             | 185,584 |        |  |               | 27,042 |       |  |   | 2,843  |   |  |   | 215,468 |  
|                             
|                             
|                             
|                             
|                              | Income (loss) from operations |  |             | (43,395 | )      |  |               | (8,695 | )     |  |   | (1,611 | ) |  |   | (53,701 | )
|                             
|                             
|                             
|                             
|                              | Long-lived assets             |  |             | 256,973 |        |  |               | 1,635  |       |  |   | 1,594  |   |  |   | 260,202 |  



---

|(1) |  | Principally represents operations in the United States
|--- |  | ------------------------------------------------------

F-20



---



##### Table of Contents



QUEST SOFTWARE, INC.

FINANCIAL STATEMENT SCHEDULE

SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNT

|                                                  |                                                   |           |                |          |           |            |       |        |  |   |            |        |   |   |       |       | 
|------------------------------------------------- | ------------------------------------------------- | --------- | -------------- | -------- | --------- | ---------- | ----- | ------ |  | - | ---------- | ------ | - | - | ----- | ----- | 
|                                                  |                                                   |           | Balance at     |          | Charges   |            |       |        |  |   | Balance at
|                                                  |                                                   |           | Beginning      |          | Costs and |            |       |        |  |   | End of    
|Description                                       |                                                   | of Period |                | Expenses |           | Deductions |       | Period
|                                                  |                                                   |           |                |          |           |            |       |       
|                                                  |                                                   |           | (In
Thousands)
|Year ended December 31, 1999:                     |                                                   |           |                |          |           |            |       |        |  |   |            |        |   |   |       |      
|                                                 
|                                                 
|                                                 
|                                                 
|Allowance for doubtful accounts and sales returns |                                                   | $         | 1,052          |          |           | $          | 5,451 |        |  | $ | (3,264     | )      |   | $ | 3,239 |      
|                                                 
|                                                 
|                                                 
|                                                 
|Year ended December 31, 2000:                     |                                                   |           |                |          |           |            |       |        |  |   |            |        |   |   |       |      
|                                                 
|                                                 
|                                                 
|                                                 
|Allowance for doubtful accounts and sales returns |                                                   | $         | 3,239          |          |           | $          | 9,990 |        |  | $ | (3,253     | )      |   | $ | 9,976 |      
|                                                 
|                                                 
|                                                 
|                                                 
|Year ended December 31, 2001:                     |                                                   |           |                |          |           |            |       |        |  |   |            |        |   |   |       |      
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Allowance for doubtful accounts and sales returns |           | $              | 9,976    |           |            | $     | 7,146  |  |   | $          | (7,171 | ) |   | $     | 9,951 | 

S-1



---



##### Table of Contents



EXHIBIT INDEX

|        |  |                                                                                                                                                    
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT |  |                                                                                                                                                    
|NUMBER  |  | EXHIBIT TITLE                                                                                                                                      
|        |  |                                                                                                                                                    
|3.1     |  | Second Amended and Restated Articles of Incorporation.(1)                                                                                          
|        |  |                                                                                                                                                    
|3.2     |  | Second Amended and Restated Bylaws, as amended.(2)                                                                                                 
|        |  |                                                                                                                                                    
|3.3     |  | Certificate of Amendment of Second Amended and Restated
Articles of Incorporation.(3)                                                              
|        |  |                                                                                                                                                    
|3.4     |  | Certificate of Amendment of Bylaws(4)                                                                                                              
|        |  |                                                                                                                                                    
|4.1     |  | Form of Registrants Specimen Common Stock Certificate.(1)                                                                                         
|        |  |                                                                                                                                                    
|10.1++  |  | Registrants 1998 Stock Option/Stock Issuance Plan.(1)                                                                                             
|        |  |                                                                                                                                                    
|10.2++  |  | Registrants 1999 Stock Incentive Plan.(1)                                                                                                         
|        |  |                                                                                                                                                    
|10.3++  |  | Registrants 1999 Employee Stock Purchase Plan.(1)                                                                                                 
|        |  |                                                                                                                                                    
|10.4    |  | Form of Directors and Officers Indemnification
Agreement.(1)                                                                                     
|        |  |                                                                                                                                                    
|10.5    |  | Office Space Lease dated as of June 17, 1999 between The
Irvine Company and Quest Software, Inc.(1)                                                
|        |  |                                                                                                                                                    
|10.6    |  | Office Lease between The Northwestern Mutual Life Insurance
Company (Landlord) and Quest Software, Inc. (Tenant) dated
as of September 30, 1999.(2)
|        |  |                                                                                                                                                    
|10.7    |  | Office lease, dated June 2000, between Fund VIII and Fund IX
Associates and Quest Software, Inc.(5)                                                
|        |  |                                                                                                                                                    
|10.8++  |  | Registrants 2001 Stock Incentive Plan(6)                                                                                                          
|        |  |                                                                                                                                                    
|21.1    |  | Subsidiaries of the Company.                                                                                                                       
|        |  |                                                                                                                                                    
|23.1    |  | Consent of Deloitte & Touche LLP.                                                                                                                  



|(1) |  | Incorporated herein by reference to the Companys Registration
Statement on
Form S-1 and all amendments thereto (File No. 333-80543).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                      
|(2) |  | Incorporated herein by reference to the Companys Registration
Statement on
Form S-1 and all amendments thereto (File No. 333-30816).
|    |  |                                                                                                                                      
|(3) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form
10-Q for the period ended June 30, 2000.                  
|    |  |                                                                                                                                      
|(4) |  | Incorporated herein by reference to the Companys Quarterly Report on Form
10-Q for the period ended June 30, 2001                   
|    |  |                                                                                                                                      
|(5) |  | Incorporated herein by reference to the Companys Annual Report on Form
10-K for the year ended December 30, 2000                    
|    |  |                                                                                                                                      
|(6) |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-8 (File No. 333-82784) filed on February 14, 2002 
|    |  |                                                                                                                                      
|++  |  | Indicates a management contract or compensatory arrangement.                                                                         
|    |  |