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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended September 30, 2003



OR



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



For the transition period from
 to



COMMISSION FILE NO. 000-26937



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QUEST SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



|California                                                     |  | 33-0231678                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|8001 Irvine Center Drive Irvine, California                    |  | 92618                               
|(Address of principal executive offices)                       |  | (Zip code)                          



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



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



Yes  x    No ̈



Indicate by check mark whether the Registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act)



Yes  x    No ̈



The number of shares outstanding of the Registrants Common Stock, no
par value, as of October 31, 2003 was 93,047,473.



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##### Table of Contents

QUEST SOFTWARE, INC.



FORM 10-Q



TABLE OF CONTENTS



|                              |  |                                                                                                                                           |  | PageNumber
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | ----------
|PART I. FINANCIAL INFORMATION |  |                                                                                                                                          
|                              |  |                                                                                                                                          
|Item 1.                       |  | Financial Statements                                                                                                                      |  |           
|                              |  |                                                                                                                                          
|                              |  | Condensed Consolidated Balance Sheets as of December 31, 2002 and September 30, 2003 (unaudited)                                          |  | 2         
|                              |  |                                                                                                                                          
|                              |  | Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2003 (unaudited)               |  | 3         
|                              |  |                                                                                                                                          
|                              |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2003 (unaudited)                         |  | 4         
|                              |  |                                                                                                                                          
|                              |  | Condensed Consolidated Statements of Comprehensive Operations for the Three and Nine Months Ended September 30, 2002 and 2003 (unaudited) |  | 5         
|                              |  |                                                                                                                                          
|                              |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                          |  | 6         
|                              |  |                                                                                                                                          
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                     |  | 13        
|                              |  |                                                                                                                                          
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risks                                                                               |  | 27        
|                              |  |                                                                                                                                          
|Item 4.                       |  | Controls and Procedures                                                                                                                   |  | 28        
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                                          
|                              |  |                                                                                                                                          
|Item 1.                       |  | Legal Proceedings                                                                                                                         |  | 29        
|                              |  |                                                                                                                                          
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                          |  | 29        
|                              | 
|SIGNATURES                    |  | 30                                                                                                                                       



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##### Table of Contents

PART IFINANCIAL INFORMATION



Item 1:Financial Statements



QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)



|                                                                                                                                                          |  | December 31,2002 |         |   | September 30,2003 |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ------- | - | ----------------- | -
|ASSETS                                                                                                                                                    |  |                  |         |   |                   |  
|Current assets:                                                                                                                                           |  |                  |         |   |                   |  
|Cash and cash equivalents                                                                                                                                 |  | $                | 64,283  |   |                   | $
|Short-term marketable securities                                                                                                                          |  |                  | 27,841  |   |                   |  
|Accounts receivable, net                                                                                                                                  |  |                  | 39,898  |   |                   |  
|Prepaid expenses and other current assets                                                                                                                 |  |                  | 9,653   |   |                   |  
|Deferred income taxes                                                                                                                                     |  |                  | 9,491   |   |                   |  
|                                                                                                                                                          |  |                  |         |   |                   |  
|Total current assets                                                                                                                                      |  |                  | 151,166 |   |                   |  
|Property and equipment, net                                                                                                                               |  |                  | 44,505  |   |                   |  
|Long-term marketable securities                                                                                                                           |  |                  | 115,422 |   |                   |  
|Goodwill                                                                                                                                                  |  |                  | 231,717 |   |                   |  
|Amortizing intangible assets, net                                                                                                                         |  |                  | 31,116  |   |                   |  
|Deferred income taxes                                                                                                                                     |  |                  | 15,014  |   |                   |  
|Other assets                                                                                                                                              |  |                  | 2,341   |   |                   |  
|                                                                                                                                                          |  |                  |         |   |                   |  
|Total assets                                                                                                                                              |  | $                | 591,281 |   |                   | $
|                                                                                                                                                          |  |                  |         |   |                   |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                      |  |                  |         |   |                   |  
|Current liabilities:                                                                                                                                      |  |                  |         |   |                   |  
|Accounts payable                                                                                                                                          |  | $                | 5,308   |   |                   | $
|Accrued compensation                                                                                                                                      |  |                  | 13,900  |   |                   |  
|Other accrued expenses                                                                                                                                    |  |                  | 23,678  |   |                   |  
|Income taxes payable                                                                                                                                      |  |                  | 1,262   |   |                   |  
|Deferred revenue                                                                                                                                          |  |                  | 63,210  |   |                   |  
|                                                                                                                                                          |  |                  |         |   |                   |  
|Total current liabilities                                                                                                                                 |  |                  | 107,358 |   |                   |  
|Long-term liabilities and other                                                                                                                           |  |                  | 5,941   |   |                   |  
|Commitments and contingencies (Notes 4, 10 and 11)                                                                                                        |  |                  |         |   |                   |  
|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; 90,715 and 92,810 issued and outstanding at December 31, 2002 and September
30, 2003, respectively |  |                  | 562,476 |   |                   |  
|Accumulated deficit                                                                                                                                       |  |                  | (68,589 | ) |                   |  
|Accumulated other comprehensive income                                                                                                                    |  |                  | 1,309   |   |                   |  
|Notes receivable from sale of common stock                                                                                                                |  |                  | (17,214 | ) |                   |  
|                                                                                                                                                          |  |                  |         |   |                   |  
|Net shareholders equity                                                                                                                                  |  |                  | 477,982 |   |                   |  
|                                                                                                                                                          |  |                  |         |   |                   |  
|Total liabilities and shareholders equity                                                                                                                |  | $                | 591,281 |   |                   | $
|                                                                                                                                                          |  |                  |         |   |                   |  



See accompanying notes
to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                            |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|------------------------------------------- |  | ------------------------------- | ------ | ------------------------------
|                                            |  | 2002                            |        |                               
|Revenues:                                   |  |                                 |        |                               
|Licenses                                    |  | $                               | 39,851 |                               
|Services                                    |  |                                 | 23,051 |                               
|                                            |  |                                 |        |                               
|Total revenues                              |  |                                 | 62,902 |                               
|Cost of revenues:                           |  |                                 |        |                               
|Licenses                                    |  |                                 | 904    |                               
|Services                                    |  |                                 | 4,321  |                               
|Amortization of purchased intangible assets |  |                                 | 1,288  |                               
|                                            |  |                                 |        |                               
|Total cost of revenues                      |  |                                 | 6,513  |                               
|                                            |  |                                 |        |                               
|Gross profit                                |  |                                 | 56,389 |                               
|Operating expenses:                         |  |                                 |        |                               
|Sales and marketing                         |  |                                 | 31,096 |                               
|Research and development                    |  |                                 | 14,685 |                               
|General and administrative                  |  |                                 | 6,201  |                               
|Amortization of purchased intangible assets |  |                                 | 479    |                               
|                                            |  |                                 |        |                               
|Total operating expenses                    |  |                                 | 52,461 |                               
|                                            |  |                                 |        |                               
|Income from operations                      |  |                                 | 3,928  |                               
|Other income, net                           |  |                                 | 1,221  |                               
|Write-down of investments                   |  |                                 |       |                               
|Loss on sale of aircraft                    |  |                                 | (790   | )                             
|                                            |  |                                 |        |                               
|Income before income tax provision          |  |                                 | 4,359  |                               
|Income tax provision                        |  |                                 | 2,089  |                               
|                                            |  |                                 |        |                               
|Net income                                  |  | $                               | 2,270  |                               
|                                            |  |                                 |        |                               
|Net income per share:                       |  |                                 |        |                               
|Basic                                       |  | $                               | 0.03   |                               
|                                            |  |                                 |        |                               
|Diluted                                     |  | $                               | 0.02   |                               
|                                            |  |                                 |        |                               
|Weighted average shares:                    |  |                                 |        |                               
|Basic                                       |  |                                 | 90,256 |                               
|Diluted                                     |  |                                 | 92,195 |                               



See accompanying notes
to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                  |  | Nine Months EndedSeptember 30, |        
|--------------------------------------------------------------------------------- |  | ------------------------------ | -------
|                                                                                  |  | 2002                           |        
|Cash flows from operating activities:                                             |  |                                |        
|Net income                                                                        |  | $                              | 6,575  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                |        
|Depreciation and amortization                                                     |  |                                | 17,075 
|Compensation expense associated with stock option grants                          |  |                                | 921    
|Accrued interest receivable from shareholders                                     |  |                                | (99    
|Deferred income taxes                                                             |  |                                | (21    
|Provision for bad debts                                                           |  |                                | 631    
|Write-down of investments                                                         |  |                                | 1,095  
|Loss on sale of aircraft                                                          |  |                                | 790    
|Changes in operating assets and liabilities, net of effects of acquisitions:      |  |                                |        
|Accounts receivable                                                               |  |                                | 9,140  
|Prepaid expenses and other current assets                                         |  |                                | (1,556 
|Other assets                                                                      |  |                                | 176    
|Accounts payable                                                                  |  |                                | (690   
|Accrued compensation                                                              |  |                                | (641   
|Other accrued expenses                                                            |  |                                | (5,126 
|Income taxes payable                                                              |  |                                | 4,081  
|Deferred revenue                                                                  |  |                                | 3,974  
|Other liabilities                                                                 |  |                                | (1,255 
|                                                                                  |  |                                |        
|Net cash provided by operating activities                                         |  |                                | 35,070 
|Cash flows from investing activities:                                             |  |                                |        
|Purchases of property and equipment                                               |  |                                | (3,330 
|Cash paid for acquisitions, net of cash acquired                                  |  |                                | (4,063 
|Proceeds from sale of aircraft                                                    |  |                                | 1,932  
|Purchases of marketable securities                                                |  |                                | (43,873
|Sales and maturities of marketable securities                                     |  |                                | 29,868 
|                                                                                  |  |                                |        
|Net cash used in investing activities                                             |  |                                | (19,466
|Cash flows from financing activities:                                             |  |                                |        
|Repayment of notes payable                                                        |  |                                | (1,835 
|Repayment of note receivable from shareholder                                     |  |                                | 685    
|Repayment of capital lease obligations                                            |  |                                | (193   
|Proceeds from the exercise of stock options                                       |  |                                | 1,379  
|Proceeds from employee stock purchase plan                                        |  |                                | 4,480  
|                                                                                  |  |                                |        
|Net cash provided by financing activities                                         |  |                                | 4,516  
|Effect of exchange rate changes on cash and cash equivalents                      |  |                                | (709   
|                                                                                  |  |                                |        
|Net increase in cash and cash equivalents                                         |  |                                | 19,411 
|Cash and cash equivalents, beginning of period                                    |  |                                | 30,279 
|                                                                                  |  |                                |        
|Cash and cash equivalents, end of period                                          |  | $                              | 49,690 
|                                                                                  |  |                                |        
|Supplemental disclosures of condensed consolidated cash flow information:         |  |                                |        
|Cash paid for:                                                                    |  |                                |        
|Interest                                                                          |  | $                              | 41     
|                                                                                  |  |                                |        
|Income taxes                                                                      |  | $                              | 437    
|                                                                                  |  |                                |        
|Supplemental schedule of non-cash investing and financing activities:             |  |                                |        
|Unrealized (loss) gain on available-for-sale securities                           |  | $                              | 1,170  
|                                                                                  |  |                                |        
|Tax benefit related to stock option exercises                                     |  | $                              | 5,132  
|                                                                                  |  |                                |        



See Note 4 for details of assets
acquired and liabilities assumed in purchase transactions.



See
accompanying notes to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS

(In thousands)

(Unaudited)



|                                                        |  | Three Months EndedSeptember 30, |       |      |   |       | Nine Months EndedSeptember 30, | 
|------------------------------------------------------- |  | ------------------------------- | ----- | ---- | - | ----- | ------------------------------ | 
|                                                        |  | 2002                            |       | 2003 |   |       |                                | 
|Net income                                              |  | $                               | 2,270 |      | $ | 4,438 |                                | 
|Other comprehensive income:                             |  |                                 |       |      |   |       |                                | 
|Unrealized (loss) gain on available-for-sale securities |  |                                 | 365   |      |   | (277  | )                              | 
|                                                        |  |                                 |       |      |   |       |                                | 
|Comprehensive income                                    |  | $                               | 2,635 |      | $ | 4,161 |                                | 
|                                                        |  |                                 |       |      |   |       |                                | 



See accompanying notes
to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



1. Basis of
Presentation



Our accompanying unaudited condensed
consolidated financial statements as of September 30, 2003 and for the three and nine months ended September 30, 2002 and 2003, reflect all adjustments (consisting of normal recurring accruals) that, in the opinion of management, are necessary for a
fair presentation of the results for the interim periods presented. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain reclassifications
have been made to the September 30, 2002 balances in order to conform to the September 30, 2003 presentation.



These financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for
the year ended December 31, 2002, as amended.



Operating
results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for any future period.



2. New Accounting Pronouncements



In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. We
adopted the disclosure provisions of FIN 45 during the fourth quarter of fiscal 2002 and we provided the required disclosures in Note 11 Commitments and Contingencies. We adopted the recognition provisions of FIN 45 effective
January 1, 2003 and such adoption did not have an impact on our condensed consolidated results of operations or financial position.



In December 2002, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 148 (SFAS 148),
Accounting for Stock-Based CompensationTransition and Disclosure. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods for voluntary transition to SFAS
123s fair value method of accounting for stock-based employee compensation (the fair value method). SFAS 148 also requires disclosure of the effects of an entitys accounting policy with respect to stock-based employee
compensation on reported net income and earnings per share in annual and interim financial statements. We adopted the provisions of SFAS 148 effective January 1, 2003 and have provided the disclosures required under SFAS 148 herein. Adoption of SFAS
148 did not impact our consolidated results of operations and financial position since we have not adopted the fair value method. However, should we be required to adopt the fair value method in the future, such adoption could have a material impact
on our consolidated results of operations or financial position.



We account 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. As permitted by
SFAS 123, as amended by SFAS 148, we have chosen to continue to account for our employee stock-based compensation plans under APB Opinion No. 25 and provide the expanded disclosures specified in SFAS 123, as amended by SFAS 148. Had employee stock
based compensation cost been determined using the fair value method our net income would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):



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|                                                                                                                           |  | Three Months EndedSeptember 30, |        |   |      |   | Nine Months Ended  September 30, |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | -------------------------------- | -
|                                                                                                                           |  | 2002                            |        |   | 2003 |   |                                  |  
|Net income:                                                                                                                |  |                                 |        |   |      |   |                                  |  
|As reported                                                                                                                |  | $                               | 2,270  |   |      | $ | 4,438                            |  
|Add: Stock-based compensation expense included in reported net income, net of related tax effects                          |  |                                 | 219    |   |      |   | 78                               |  
|Deduct: Total stock-based compensation determined under fair value based method for all awards, net of related tax
effects |  |                                 | (6,037 | ) |      |   | (6,643                           | )
|                                                                                                                           |  |                                 |        |   |      |   |                                  |  
|Pro forma                                                                                                                  |  | $                               | (3,548 | ) |      | $ | (2,127                           | )
|                                                                                                                           |  |                                 |        |   |      |   |                                  |  
|Basic net income per share:                                                                                                |  |                                 |        |   |      |   |                                  |  
|As reported                                                                                                                |  | $                               | 0.03   |   |      | $ | 0.05                             |  
|Pro forma                                                                                                                  |  | $                               | (0.04  | ) |      | $ | (0.02                            | )
|Diluted net income per share:                                                                                              |  |                                 |        |   |      |   |                                  |  
|As reported                                                                                                                |  | $                               | 0.02   |   |      | $ | 0.05                             |  
|Pro forma                                                                                                                  |  | $                               | (0.04  | ) |      | $ | (0.02                            | )



For purposes of
estimating the compensation cost of our option grants in accordance with SFAS 123, as amended by SFAS 148, 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 the three and nine months ended September 30, 2002 and 2003 were as follows:



|                          |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|------------------------- |  | ------------------------------- | - |  | ------------------------------ | -
|                          |  | 2002                            |   |  | 2003                           |  
|Risk-free interest rates  |  | 5                               | % |  | 4                              | %
|Expected life (in years)  |  | 5                               |   |  | 5                              |  
|Expected stock volatility |  | 86                              | % |  | 64                             | %



In January 2003, the
FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. We adopted the provisions of FIN 46 effective January 1, 2003. We do not have any variable interest entities; thus adoption of FIN 46 did not have an impact on our consolidated results of
operations or financial position.



In April 2003, the FASB
issued SFAS No. 149 (SFAS 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging. The statement requires that contracts with
comparable characteristics be accounted for similarly and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. We adopted SFAS No. 149 effective July 1, 2003 and such adoption did not have an impact on our condensed consolidated results of operations
or financial position.



In May 2003, the FASB issued SFAS No.
150 (SFAS 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15,
2003. We adopted SFAS No. 150 effective July 1, 2003 and such adoption did not have an impact on our condensed consolidated results of operations or financial position because we have not issued any of these types of financial instruments.



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3. Amortizing Intangible Assets



Amortizing intangible assets as of December 31, 2002 and September 30, 2003, respectively, are comprised of the following
(in thousands):



|                      |  | December 31, 2002   |        |                         |   | September 30, 2003 |     | 
|--------------------- |  | ------------------- | ------ | ----------------------- | - | ------------------ | --- | 
|                      |  | GrossCarryingAmount |        | AccumulatedAmortization |   |                    | Net | 
|Acquired technology   |  | $                   | 44,017 |                         | $ | (18,785            | )   | 
|Customer list         |  |                     | 5,101  |                         |   | (1,945             | )   | 
|Non-compete agreement |  |                     | 2,200  |                         |   | (1,008             | )   | 
|Trademark             |  |                     | 1,450  |                         |   | (48                | )   | 
|Other                 |  |                     | 2,264  |                         |   | (2,130             | )   | 
|                      |  |                     |        |                         |   |                    |     | 
|                      |  | $                   | 55,032 |                         | $ | (23,916            | )   | 
|                      |  |                     |        |                         |   |                    |     | 



Amortization expense
for amortizing intangible assets was $2.8 million and $9.1 million for the three and nine months ended September 30, 2003, respectively. Estimated amortization expense related to intangible assets acquired prior to September 30, 2003 is $2.1 million
for the remainder of fiscal 2003, and $6.8 million, $5.0 million, $4.7 million, $4.0 million and $4.3 million for fiscal year 2004, 2005, 2006, 2007 and thereafter, respectively. All intangible assets currently recorded will be fully amortized by
the end of 2009.



4. Acquisitions



We acquired the outstanding shares of eCritical Inc.
(eCritical), a provider of performance management solutions for network-enabled applications on April 3, 2003. eCriticals products extend our software monitoring solutions beyond the internal firewall to enable information
technology (IT) administrators to monitor end user application response times and serve as an additional complement to our end-to-end response time management solution. The purchase price for eCritical was $2.1 million, consisting of
stock of $1.8 million, of which $0.2 million was withheld in escrow for certain indemnification obligations of the selling shareholders, guaranteed future payments of $0.2 million related to employment agreements with certain key employees, and
direct acquisition costs of $0.1 million. Goodwill in the amount of $1.6 million was assigned to the license segment of our business and is not expected to be deductible for tax purposes.



An additional non-guaranteed amount of up to $0.2 million may be earned in the two years following the acquisition if
certain sales of eCritical products, based on a formula, exceed $1.0 million following the close of the acquisition. These non-guaranteed payments will be recorded as compensation expense when and if such amounts are earned.



The acquisition was accounted for as a purchase with the purchase price
allocated as follows (in thousands):



|Assets                                                |  | $ | 33    |  
|----------------------------------------------------- |  | - | ----- | -
|Goodwill                                              |  |   | 1,562 |  
|Developed technology (amortization period of 5 years) |  |   | 1,200 |  
|Deferred taxes                                        |  |   | (382  | )
|Liabilities assumed                                   |  |   | (270  | )
|                                                      |  |   |       |  
|                                                      |  | $ | 2,143 |  
|                                                      |  |   |       |  



We acquired the
outstanding shares of Discus Data Solutions, Inc. (Discus), a provider of infrastructure management solutions for the Microsoft environment on May 30, 2003 in exchange for cash paid of $5.9 million, guaranteed future consideration of
$2.0 million and direct acquisition costs of $0.1 million. Discus Datas products broaden our core products for the Microsoft environment, specifically enabling Microsoft IT administrators with complementary functionality to manage user
populations within Active Directory and Exchange environments. Of the cash paid, $0.6 million was withheld in escrow for certain indemnification obligations of the selling shareholders. Goodwill in the amount of $5.8 million is not expected to be
deductible for tax purposes and was assigned as follows: $4.4 million to the license segment and $1.4 million to the services segment of our business.



We are required to pay guaranteed future consideration of $2.0 million no later than May 30, 2005. Payment of $1.0 million of the future consideration is
required to be paid earlier if the completion of certain deliverables is achieved and the remaining $1.0 million is required to be paid earlier if certain earn-out requirements are met.



An additional non-guaranteed amount of up to $1.0 million may be earned over the two year period following the acquisition
if certain sales of Discus products, based on a formula, exceed $5.0 million and $9.0 million in the first and second year, respectively, following the close of the acquisition. Such payments will be recorded as compensation expense when and if such
amounts are earned.



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The acquisition was accounted for as a purchase with the purchase price allocated as follows (in
thousands):



|Assets                                                |  | $ | 746    |  
|----------------------------------------------------- |  | - | ------ | -
|Goodwill                                              |  |   | 5,825  |  
|Developed technology (amortization period of 5 years) |  |   | 2,200  |  
|Customer list (amortization period of 5 years)        |  |   | 1,200  |  
|Deferred taxes                                        |  |   | (1,229 | )
|Liabilities assumed                                   |  |   | (716   | )
|                                                      |  |   |        |  
|                                                      |  | $ | 8,026  |  
|                                                      |  |   |        |  



We acquired the
outstanding shares of BB4 Technologies, Inc., a provider of systems availability monitoring solutions in February 2002 and Sitraka, Inc., a leading developer of application server performance management products in November 2002. Actual results of
operations of the companies acquired in 2002 and of those acquired in the three months ended June 30, 2003 are included in the condensed consolidated financial statements from the dates of acquisition. The pro forma results of operations data for
the three and nine months ended September 30, 2002 and 2003 presented below assume that the acquisitions made in 2002 and 2003 had been made at the beginning of the fiscal years presented and include amortization of 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
each fiscal year (in thousands):



|                                       |  | Three Months EndedSeptember 30, |        |   |  | Nine Months EndedSeptember 30,
|-------------------------------------- |  | ------------------------------- | ------ | - |  | ------------------------------
|                                       |  | 2002                            |        |   |  |                               
|Revenues                               |  | $                               | 66,923 |   |  |                               
|Net income                             |  |                                 | (16    | ) |  |                               
|Net income per sharebasic and diluted |  | $                               |       |   |  |                               



The changes in the
carrying amount of goodwill by reportable operating segment for the nine months ended September 30, 2003 is as follows (in thousands):



|                                                               |  | Licenses |         | Services |   | Total 
|-------------------------------------------------------------- |  | -------- | ------- | -------- | - | ------
|Balance as of December 31, 2002                                |  | $        | 176,105 |          | $ | 55,612
|Goodwill acquired during nine months ended September 30, 2003: |  |          |         |          |   |       
|eCritical                                                      |  |          | 1,562   |          |   |      
|Discus                                                         |  |          | 4,427   |          |   | 1,398 
|Goodwill adjustment for Sitraka severance costs                |  |          | 450     |          |   | 142   
|                                                               |  |          |         |          |   |       
|Balance as of September 30, 2003                               |  | $        | 182,544 |          | $ | 57,152
|                                                               |  |          |         |          |   |       



5. Other Compensation Costs



We record compensation expense for options granted to
purchase common stock if the related exercise price of the option is below fair market value. The expense equals the difference between the fair market value of our common stock on the grant or assumption date and the exercise price of the stock
options. We assumed certain stock options in connection with various acquisitions. We also record compensation costs from additional payroll taxes incurred when employees exercise stock options based on the difference between the exercise price and
the market price on the date of exercise.



The following table
shows the allocation of such costs to cost of licenses and services revenues and operating expenses based on the related headcount for the three and nine months ended September 30, 2002 and 2003 (in thousands):



|                               |  | Three Months EndedSeptember 30, |     |      |   | Nine Months Ended  September 30,
|------------------------------ |  | ------------------------------- | --- | ---- | - | --------------------------------
|                               |  | 2002                            |     | 2003 |   |                                 
|Cost of licenses revenues      |  | $                               |    |      | $ | 1                               
|Cost of services revenues      |  |                                 | 31  |      |   | 13                              
|Sales and marketing            |  |                                 | 203 |      |   | 82                              
|Research and development       |  |                                 | 177 |      |   | 78                              
|General and administrative     |  |                                 | 51  |      |   | 12                              
|                               |  |                                 |     |      |   |                                 
|Total other compensation costs |  | $                               | 462 |      | $ | 186                             
|                               |  |                                 |     |      |   |                                 



We expect amortization
to be insignificant during the fourth quarter of 2003 and throughout 2004, which corresponds to the remaining vesting periods of the related options.



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Consistent with the provisions of Accounting Principles Board Opinion No. 25 and Emerging Issues Task
Force No. 00-23, we decrease other compensation cost when an employee forfeits an award prior to vesting in the period of forfeiture.



6. Net Income Per Share



We compute net income per share in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is computed by dividing
net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other common stock equivalents, including stock options, in the
weighted-average number of common shares outstanding for a period, if dilutive.



The following table summarizes our earnings per share computation for the three and nine months ended September 30, 2002 and 2003 (in thousands, except per share data):



|                                                                                     |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|------------------------------------------------------------------------------------ |  | ------------------------------- | ------ | ------------------------------
|                                                                                     |  | 2002                            |        | 2003                          
|Net income                                                                           |  | $                               | 2,270  |                               
|Basic net income per shareweighted average shares                                   |  |                                 | 90,256 |                               
|Incremental common shares attributable to shares issuable under employee stock plans |  |                                 | 1,939  |                               
|                                                                                     |  |                                 |        |                               
|Diluted net income per shareweighted average shares                                 |  |                                 | 92,195 |                               
|                                                                                     |  |                                 |        |                               
|Net income per sharebasic                                                           |  | $                               | 0.03   |                               
|                                                                                     |  |                                 |        |                               
|Net income per sharediluted                                                         |  | $                               | 0.02   |                               
|                                                                                     |  |                                 |        |                               



For the three and nine
months ended September 30, 2003, options to purchase 8,868 and 9,289 shares of common stock, respectively, with a weighted average price of $19.65 and $19.41, respectively, were anti-dilutive because the exercise price of the options was greater
than the average fair market value of our common stock for the periods then ended.



7. Shareholders Equity



In January and
July of 2003, 286,815 and 311,884 shares of common stock were purchased under our Employee Stock Purchase Plan at a price of $7.97 and $7.52 per share, respectively.



8. Stock Option Plans



The following table summarizes information about stock options outstanding as of September 30, 2003 (in thousands, except for per share data):



|                                             |  | Number ofShares |   |  | Weighted-AverageExercise Price
|-------------------------------------------- |  | --------------- | - |  | ------------------------------
|Balance at December 31, 2002                 |  | 19,710          |   |  | $                             
|Granted                                      |  | 6,614           |   |  |                               
|Exercised                                    |  | (1,298          | ) |  |                               
|Canceled                                     |  | (1,618          | ) |  |                               
|                                             |  |                 |   |  |                               
|Balance at September 30, 2003                |  | 23,408          |   |  |                               
|                                             |  |                 |   |  |                               
|Options exercisable as of September 30, 2003 |  | 6,660           |   |  | $                             
|                                             |  |                 |   |  |                               



The weighted-average
fair value of options granted during the nine months ended September 30, 2003 was $6.33.



9. 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 our chief operating decision maker, or decision-making group, in
deciding how to allocate resources and in assessing performance. Our operating segments are managed separately because each segment represents a strategic business unit that offers different products or services.



Our reportable operating segments are Licenses and Services. The Licenses
segment develops and markets licenses to use our

software products. The Services segment provides after-sale support for software products and fee-based
training and consulting services related to our software products.



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



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Reportable segment data for the three and nine months ended September 30, 2002 and 2003 is as follows (in
thousands):



|                                      |  | Licenses |         | Services |   | Total 
|------------------------------------- |  | -------- | ------- | -------- | - | ------
|Three months ended September 30, 2002 |  |          |         |          |   |       
|Revenues                              |  | $        | 39,851  |          | $ | 23,051
|Cost of Revenues                      |  |          | 2,192   |          |   | 4,321 
|                                      |  |          |         |          |   |       
|Gross profit                          |  | $        | 37,659  |          | $ | 18,730
|                                      |  |          |         |          |   |       
|Three months ended September 30, 2003 |  |          |         |          |   |       
|Revenues                              |  | $        | 41,423  |          | $ | 31,841
|Cost of Revenues                      |  |          | 2,925   |          |   | 5,267 
|                                      |  |          |         |          |   |       
|Gross profit                          |  | $        | 38,498  |          | $ | 26,574
|                                      |  |          |         |          |   |       
|Nine months ended September 30, 2002  |  |          |         |          |   |       
|Revenues                              |  | $        | 116,493 |          | $ | 67,890
|Cost of Revenues                      |  |          | 6,804   |          |   | 13,285
|                                      |  |          |         |          |   |       
|Gross profit                          |  | $        | 109,689 |          | $ | 54,605
|                                      |  |          |         |          |   |       
|Nine months ended September 30, 2003  |  |          |         |          |   |       
|Revenues                              |  | $        | 125,310 |          | $ | 89,988
|Cost of Revenues                      |  |          | 9,489   |          |   | 15,805
|                                      |  |          |         |          |   |       
|Gross profit                          |  | $        | 115,821 |          | $ | 74,183
|                                      |  |          |         |          |   |       



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



|                                      |  | NorthAmerica (1) |         | Europe |   |        | OtherInternational |  |   | Total 
|------------------------------------- |  | ---------------- | ------- | ------ | - | ------ | ------------------ |  | - | ------
|Three months ended September 30, 2002 |  |                  |         |        |   |        |                    |  |   |       
|Revenues                              |  | $                | 47,451  |        | $ | 14,020 |                    |  | $ | 1,431 
|Gross profit                          |  |                  | 46,743  |        |   | 8,883  |                    |  |   | 763   
|Income (loss) from operations         |  |                  | 5,430   |        |   | (1,533 | )                  |  |   | 31    
|Long-lived assets                     |  |                  | 429,178 |        |   | 2,890  |                    |  |   | 1,127 
|Three months ended September 30, 2003 |  |                  |         |        |   |        |                    |  |   |       
|Revenues                              |  | $                | 53,293  |        | $ | 17,877 |                    |  | $ | 2,094 
|Gross profit                          |  |                  | 47,987  |        |   | 15,772 |                    |  |   | 1,313 
|Income (loss) from operations         |  |                  | 2,939   |        |   | 5,090  |                    |  |   | (2,117
|Long-lived assets                     |  |                  | 447,648 |        |   | 2,685  |                    |  |   | 7,031 
|Nine months ended September 30, 2002  |  |                  |         |        |   |        |                    |  |   |       
|Revenues                              |  | $                | 139,018 |        | $ | 40,308 |                    |  | $ | 5,057 
|Gross profit                          |  |                  | 135,519 |        |   | 25,658 |                    |  |   | 3,117 
|Income (loss) from operations         |  |                  | 9,715   |        |   | (3,391 | )                  |  |   | 540   
|Long-lived assets                     |  |                  | 429,178 |        |   | 2,890  |                    |  |   | 1,127 
|Nine months ended September 30, 2003  |  |                  |         |        |   |        |                    |  |   |       
|Revenues                              |  | $                | 158,380 |        | $ | 50,579 |                    |  | $ | 6,339 
|Gross profit                          |  |                  | 152,440 |        |   | 35,136 |                    |  |   | 2,428 
|Income (loss) from operations         |  |                  | 10,694  |        |   | (9,184 | )                  |  |   | 7,520 
|Long-lived assets                     |  |                  | 447,648 |        |   | 2,685  |                    |  |   | 7,031 

---

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



10. Investments



We have 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. We have classified available-for-sale securities as current or long-term based primarily on the maturity date of
the related securities.



We have a venture capital investment
in a private equity fund for business and strategic purposes, and may make additional investments of this nature in the future. At September 30, 2003, we valued this cost basis investment at $1.0 million and are committed to make additional capital
contributions to this private equity fund totaling $1.7 million. If the companies in which we make direct or indirect investments in do not complete initial public offerings or are not acquired by publicly traded companies for



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cash, we may not be able to sell these investments. In addition, even if we are able to sell these investments we cannot assure that we will be able to sell
them at a gain or even recover our investment. We do not believe that any impairment exists as of September 30, 2003.



11. Commitments and Contingencies



On July 2, 2002, Computer Associates International, Inc. filed a complaint against us and four of our employees in the U.S. District Court for the
Northern District of Illinois alleging copyright infringement and trade secret misappropriation in connection with the development of the database administration component of our Quest Central for DB2 product and seeking injunctive relief and
unspecified money damages. The complaint was amended in May 2003 to add another Quest employee as a defendant and to assert breach of contract claims against three of the individual defendants. In October 2003, CA filed a motion for preliminary
injunction. A ruling on this motion is not expected until late in the first quarter of 2004. If granted, we would be preliminarily enjoined from licensing Quest Central for DB2. We will vigorously defend CAs claims and do not believe that this
matter will have a material adverse effect on our results of operations or financial condition.



After we announced on July 23, 2003 that we would restate certain financial results as a result of our discovery of a computational error relating to
foreign currency conversions, numerous separate complaints purporting to be class actions were filed in the United States District Court for the Central District of California alleging that we and some of our officers and directors violated
provisions of the Securities Exchange Act of 1934. The complaints contain varying allegations, including that we made materially false and misleading statements with respect to our financial results for 2002 and the quarter ended March 31, 2003
included in our filings with the SEC and press releases. Orders designating a lead plaintiff and consolidating the federal class action complaints were issued by the U. S. District Court in late October 2003, and an amended consolidated class action
complaint is expected to be filed late in the fourth quarter of 2003. In addition, one complaint purporting to be a derivative action has been filed in California state court against some of our directors and officers. This complaint is based on the
same facts and circumstances described in the class action complaints and generally alleges that the named directors and officers breached their fiduciary duties by failing to oversee adequately our financial reporting. All of the complaints
generally seek an unspecified amount of damages. The cases are in the very preliminary stages and we will vigorously defend these claims; however, it is not possible for us to quantify the extent of our potential liability, if any. Accordingly, no
amounts have been accrued in the accompanying financial statements. An unfavorable outcome in any of these cases could have a material adverse effect on our business, financial condition, results of operations and cash flow. In addition, defending
any litigation may be costly and divert managements attention from the day-to-day operations of our business.



We are a party to other litigation, which we consider to be routine and incidental to our business. Management does not expect the results of any of these
actions to have a material adverse effect on our results of operations or financial condition.



In the normal course of our business, we enter into certain types of agreements that require us to indemnify or guarantee the obligations of other parties. These commitments include (i) intellectual property
indemnities to licensees of our software products, (ii) indemnities to certain lessors under office space leases for certain claims arising from our use or occupancy of the related premises, or for the obligations of our subsidiaries under leasing
arrangements, (iii) indemnities to customers, vendors and service providers for claims based on negligence or willful misconduct of our employees and agents, and (iv) indemnities to our directors and officers to the maximum extent permitted under
applicable law. The terms and duration of these commitments varies and, in some cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make thereunder; accordingly,
our actual aggregate maximum exposure related to these types of commitments cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for obligations of this nature, and no liabilities have been recorded
for these obligations in the accompanying consolidated balance sheets as the fair value of these obligations issued during the three and nine months ended September 30, 2003 was not significant to our financial position, results of operations, or
cash flows.



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Item 2:Managements Discussion and Analysis of Financial Condition and Results of Operations



The following discussion of our financial condition and results of operations 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 historical results should not be viewed as indicative of future performance.



Overview



We provide application management software solutions that maximize the availability, performance and manageability of our customers business
critical applications and their associated databases and other components. Many of our products also increase the cost effectiveness of a customers IT investments, including personnel, software and hardware.



Our revenues consist of software license fees and service fees. Our
software-licensing model is primarily based on perpetual license fees, and our license fees are calculated either on a per-server basis or, for our SQL and J2EE development, report management, Microsoft administration tools, on a per user basis.
Service revenues primarily represent the ratable recognition of software maintenance contract fees, which entitle a customer to technical support via telephone and the internet and product enhancements. These maintenance contracts have annual terms.
Customers purchase a software maintenance contract for the first year when they license a product and have the option of renewing the maintenance contract annually thereafter. Service revenues also include revenues from consulting and training
services.



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Results of Operations



The following table sets forth certain condensed consolidated statement of operations data as a percentage of total revenues, except as indicated:



|                                            |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|------------------------------------------- |  | ------------------------------- | - |  | ------------------------------ | -
|                                            |  | 2002                            |   |  | 2003                           |  
|Revenues:                                   |  |                                 |   |  |                                |  
|Licenses                                    |  | 63.4                            | % |  | 56.5                           | %
|Services                                    |  | 36.6                            |   |  | 43.5                           |  
|                                            |  |                                 |   |  |                                |  
|Total revenues                              |  | 100.0                           |   |  | 100.0                          |  
|Cost of revenues:                           |  |                                 |   |  |                                |  
|Licenses                                    |  | 1.4                             |   |  | 1.4                            |  
|Services                                    |  | 6.9                             |   |  | 7.2                            |  
|Amortization of purchased intangible assets |  | 2.0                             |   |  | 2.6                            |  
|                                            |  |                                 |   |  |                                |  
|Total cost of revenues                      |  | 10.3                            |   |  | 11.2                           |  
|                                            |  |                                 |   |  |                                |  
|Gross profit                                |  | 89.7                            |   |  | 88.8                           |  
|Operating expenses:                         |  |                                 |   |  |                                |  
|Sales and marketing                         |  | 49.4                            |   |  | 47.0                           |  
|Research and development                    |  | 23.3                            |   |  | 22.4                           |  
|General and administrative                  |  | 9.9                             |   |  | 10.2                           |  
|Amortization of purchased intangible assets |  | 0.8                             |   |  | 1.2                            |  
|                                            |  |                                 |   |  |                                |  
|Total operating expenses                    |  | 83.4                            |   |  | 80.8                           |  
|                                            |  |                                 |   |  |                                |  
|Income from operations                      |  | 6.3                             |   |  | 8.0                            |  
|Other income, net                           |  | 1.9                             |   |  | 1.8                            |  
|Write-down of investments                   |  |                                |   |  |                               |  
|Loss on sale of aircraft                    |  | (1.3                            | ) |  |                               |  
|                                            |  |                                 |   |  |                                |  
|Income before income taxes                  |  | 6.9                             |   |  | 9.8                            |  
|Income tax provision                        |  | 3.3                             |   |  | 3.8                            |  
|                                            |  |                                 |   |  |                                |  
|Net income                                  |  | 3.6                             | % |  | 6.0                            | %
|                                            |  |                                 |   |  |                                |  
|As a percentage of related revenues:        |  |                                 |   |  |                                |  
|Cost of licenses                            |  | 2.3                             | % |  | 2.5                            | %
|Cost of services                            |  | 18.7                            | % |  | 16.5                           | %



Three Months Ended September 30,
2002 and 2003



Revenues



Total revenues increased 16.5% to $73.3 million for the three months ended
September 30, 2003 from $62.9 million in the comparable period of 2002.



License RevenuesLicense revenues increased 3.9% to $41.4 million for the three months ended September 30, 2003 from $39.9 million in the comparable period of 2002. License revenues represented 56.5% of total revenues for the
three months ended September 30, 2003, compared to 63.4% for the same period of 2002. License revenues outside of North America accounted for 29.3% and 28.1% of total license revenues for the three months ended September 30, 2003 and 2002,
respectively.



License revenues growth from the
prior year primarily derived from the acquisition of Sitraka, Inc. in November 2002 as well as the impact from the devaluation of the U.S. Dollar relative to certain foreign currencies, primarily the Euro and the British Pound. We saw growth
year-over-year in our Application Performance Management and Microsoft Infrastructure products, which were offset by declines in sales of our high availability products for Oracle and our Vista output management products.



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Service RevenuesService revenues increased by 38.1% to $31.8 million for the three months
ended September 30, 2003 from $23.1 million for the same period in 2002. Service revenues outside of North America accounted for 24.5% and 18.5% of total service revenues for the three months ended September 30, 2003 and 2002, respectively. Higher
maintenance revenues derived from our greater success in renewing the maintenance contracts of our growing installed base of customers, the devaluation of the U.S. Dollar relative to certain foreign currencies, primarily the Euro and the British
Pound, and the acquisition of Sitraka in November 2002. Revenues from professional services represented 9.1% and 10.0% of total service revenues for the three months ended September 30, 2003 and 2002, respectively.



Cost of Revenues



Cost of LicensesCost of licenses primarily consists of third-party software royalties, product packaging,
documentation, duplication, delivery and personnel. Cost of licenses as a percentage of license revenues was 2.5% and 2.3% for the three months ended September 30, 2003 and 2002, respectively.



Cost of ServicesCost of services primarily consists of
personnel, facilities and systems costs used in providing support, consulting and training services. Cost of services increased by 21.9% to $5.3 million for the three months ended September 30, 2003 from $4.3 million in the same period of 2002. The
increase in cost of services is primarily due to an increase in the number of technical support personnel and consultants, mainly from the acquisition of Sitraka. Cost of services as a percentage of service revenues was 16.5% and 18.7% for the three
months ended September 30, 2003 and 2002, respectively. The margin improvement is primarily due to our continued increase in customer maintenance and support revenues with a lower associated increase in headcount.



Amortization of Purchased Intangible AssetsAmortization of
purchased intangible assets increased 47.4% to $1.9 million for the three months ended September 30, 2003 from $1.3 million in the same period of 2002. The increase is primarily due to amortization of purchased intangible assets related to the
acquisitions of eCritical and Discus in the second quarter of 2003 and Sitraka in 2002, offset slightly by purchased intangible assets from acquisitions made in 2000 that were fully amortized prior to the three month period ended September 30, 2003.
See Note 3 of the Notes to Condensed Consolidated Financial Statements for discussion of estimated future amortization expense. The useful lives of the acquired technologies range from two to seven years. See Critical
Accounting Policies and Estimates for additional discussion regarding accounting for intangible assets.



Operating Expenses



Sales and MarketingSales and marketing expenses consist primarily of the following types of costs related to our sales and marketing
activities: compensation and benefits; sales commissions; facilities and systems; recruiting; trade shows; travel and entertainment; and marketing communications. Sales and marketing expenses increased 10.7% to $34.4 million for the three months
ended September 30, 2003 from $31.1 million in the same period of 2002. The increase in sales and marketing expenses resulted from increased labor expenses, primarily due to additional headcount from our acquisition of Sitraka, higher commission and
commission rate increases and to the U.S. Dollar devaluation. In addition, employee severance costs contributed approximately $0.5 million to sales and marketing expenses in the September 2003 quarter. These increases were offset by lower marketing
program costs in the September 2003 quarter and by the inclusion in the September 2002 quarter of approximately $0.5 million in idle facilities charges compared to none in the September 2003 quarter.



Research and DevelopmentResearch and development expenses
consist primarily of compensation and benefit costs for software developers, software product managers, quality assurance and technical documentation personnel, associated facilities and systems costs and payments made to outside software
development consultants. Research and development expenses increased 11.8% to $16.4 million for the three months ended September 30, 2003 from $14.7 million in the comparable period of 2002. Additional headcount from our acquisition of Sitraka was
the primary reason for the increase in research and development expenses. The devaluation of the U.S. Dollar to the Australian and Canadian Dollars also contributed to the expense increase, because we have significant development laboratories in
Australia and Canada.



General and
AdministrativeGeneral and administrative expenses consist primarily of compensation and benefit costs for our executive, finance, legal, administrative and information services personnel, professional fees, and associated facilities and
systems costs. General and administrative expenses increased to $7.4 million for the three months ended September 30, 2003 from $6.2 million in the same period of 2002, representing an increase of $1.2 million or 19.9%. The increase is primarily
attributable to the inclusion of Sitrakas general and administrative expenses, the currency effect of the U.S. Dollar devaluation, and higher accounting fees.



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Intangible Asset AmortizationIntangible asset amortization includes the amortization of
customer lists, trademarks and a non-compete agreement associated with acquisitions. As a result of the acquisition of eCritical, Discus and Sitraka, these costs increased to $0.9 million for the three months ended September 30, 2003 from $0.5
million in the same period of 2002. All intangible assets are amortized over their estimated useful lives ranging from two to seven years and are assessed for impairment under Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.



Other Income (Expense), NetOther income (expense), net consists primarily of interest income and gains and losses on foreign exchange rate fluctuations. Other income (expense), net was $1.3 million for
the three months ended September 30, 2003 and $1.2 million for the same period of 2002. Foreign currency gains or losses are reflected in other income (expense), net and are primarily attributable to foreign currency fluctuations on certain non-U.S.
Dollar denominated assets, primarily accounts receivable in British Pounds and Euros. These amounts were $0.3 million and $(0.7) million in the three months ended September 30, 2003 and 2002, respectively. Interest income for the three months ended
September 30, 2003, decreased from the previous year as a result of lower reinvestment rates. The average interest rates of our investments are summarized under Item 3: Quantitative and Qualitative Disclosures About Market
RisksInterest Rate Risk.



Income
TaxesProvision for income taxes was $2.8 million and $2.1 million for the three months ended September 30, 2003 and 2002, respectively, representing effective rates for these periods of 38% and 48%. The decline in the effective tax rate is
largely the result of higher profitability of certain of our European subsidiaries, which are subject to a lower effective tax rate primarily as a result of historical net operating losses incurred in such jurisdictions.



Nine Months Ended September 30, 2002 and 2003



Revenues



Total revenues increased 16.8% to $215.3 million for the nine months ended September 30, 2003 from $184.4 million in the
comparable period of 2002.



License
RevenuesLicense revenues increased 7.6% to $125.3 million for the nine months ended September 30, 2003 from $116.5 million in the comparable period of 2002. License revenues represented 58.2% of total revenues for the nine months ended
September 30, 2003, compared to 63.2% for the same period of 2002. License revenues outside of North America accounted for 28.2% and 28.8% of total license revenues for the nine months ended September 30, 2003 and 2002, respectively.License
revenue growth from the prior year primarily derived from the acquisition of Sitraka, Inc. in November 2002 as well as the impact from the devaluation of the U.S. Dollar relative to certain other foreign currencies, primarily the Euro and the
British Pound, offset by a decline in sales of our high availability products for Oracle and our Vista output management products.



Service RevenuesService revenues increased by 32.5% to $90.0 million for the nine months ended September 30, 2003 from $67.9 million for the
same period in 2002. Service revenues outside of North America accounted for 24.0% and 17.4% of total service revenues for the nine months ended September 30, 2003 and 2002, respectively. Higher maintenance revenues derived from our greater success
in renewing the maintenance contracts of our growing installed base of customers, the impact from the devaluation of the U.S. Dollar relative to certain foreign currencies, primarily the Euro and the British Pound, and the acquisition of Sitraka in
November 2002. Revenues from professional services represented 9.9% and 10.2% of total service revenues for the nine months ended September 30, 2003 and 2002, respectively.



Cost of Revenues



Cost of LicensesCost of licenses as a percentage of license revenues was 2.5% and 2.4% for the nine months ended September 30, 2003 and 2002,
respectively.



Cost of ServicesCost of services
increased by $2.5 million to $15.8 million for the nine months ended September 30, 2003 from $13.3 million in the same period of 2002, representing an increase of 19.0%. Cost of services as a percentage of service revenues declined to 17.6% for the
nine months ended September 30, 2003, compared to 19.6% in the same quarter of 2002. The increase in cost of services is primarily due to an increase in the number of technical support personnel and consultants, mainly from the acquisition of
Sitraka. The margin improvement is primarily due to our continued increase in customer maintenance and support revenues with a lower associated increase in headcount.



Amortization of Purchased Intangible AssetsAmortization of purchased intangible assets increased 60.7% to $6.4
million for the nine months ended September 30, 2003 from $4.0 million in the same period of 2002. The increase is primarily due to amortization of purchased intangible assets related to the acquisitions of eCritical and Discus in the second quarter
of 2003 and Sitraka in 2002, offset slightly by purchased intangible assets from acquisitions made in 2000 that were fully amortized by the end of 2002. See Note 3 of the Notes to Condensed Consolidated Financial Statements for
discussion of estimated future amortization expense.



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The useful lives of the acquired technologies range from two to seven years. See Critical Accounting Policies and Estimates for additional
discussion regarding accounting for intangible assets.



Operating Expenses



Sales and MarketingSales and marketing
expenses increased 14.8% to $106.5 million for the nine months ended September 30, 2003 from $92.7 million in the same period of 2002. As in the June 2003 quarter, the increase in sales and marketing expenses resulted from increased labor expenses,
primarily due to additional headcount from our acquisition of Sitraka, higher commission rates for sales representatives and managers and the currency effect of the U.S. Dollar devaluation relative to the British Pound and the Euro.



Research and DevelopmentResearch and development expenses
increased 12.6% to $50.6 million for the nine months ended September 30, 2003 from $44.9 million in the comparable period of 2002. Additional headcount from our acquisition of Sitraka was the primary reason for the increase in research and
development expenses. The devaluation of the U.S. Dollar to the Australian and Canadian Dollars also contributed to the expense increase, because we have significant development laboratories in Australia and Canada.



General and AdministrativeGeneral and administrative expenses
increased to $21.3 million for the nine months ended September 30, 2003 from $18.4 million in the same period of 2002, representing an increase of $2.9 million or 15.6%. The increase is primarily attributable to the inclusion of Sitrakas
general and administrative expenses, the currency effect of the U.S. Dollar devaluation, higher legal and accounting expenses and higher directors and officers liability insurance premiums.



Intangible Asset AmortizationAs a result of the acquisition of
eCritical, Discus and Sitraka, these costs increased to $2.6 million for the nine months ended September 30, 2003 from $1.3 million in the same period of 2002. All intangible assets are amortized over their estimated useful lives ranging from two to
seven years and are assessed for impairment under Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.



Other Income (Expense), NetOther income (expense), net was $7.2
million for the nine months ended September 30, 2003 and $6.7 million for the same period of 2002. The year-over-year increase in other income (expense), net is primarily attributable to foreign currency gains on certain non-U.S. Dollar denominated
assets, primarily accounts receivable in British Pounds and Euros. Foreign currency gains were $3.8 million and $1.1 million in the nine months ended September 30, 2003 and 2002, respectively. The interest income component of other income (expense),
net for the nine months ended September 30, 2003 decreased year-over-year because of lower reinvestment rates. The average interest rates of our investments are summarized under Item 3: Quantitative and Qualitative Disclosures About Market
RisksInterest Rate Risk.



Write-Down of
InvestmentsWrite-down of investments consists of adjustments for other than temporary impairment of minority equity investments that we make in non-publicly traded companies. These investments are included in other assets on our
consolidated balance sheet. During the second quarter of 2002, we recorded a write down of $1.1 million associated with an other-than-temporary impairment. No such impairment charge was recorded in the nine months ended September 30, 2003.



Income TaxesProvision for income taxes was $6.1
million and $5.1 million for the nine months ended September 30, 2003 and 2002, respectively, representing effective rates for these periods of 38% and 44%. The decline in the effective tax rate is largely the result of higher profitability of
certain of our European subsidiaries, which are subject to a lower effective tax rate primarily as a result of historical net operating losses in such jurisdictions.



Liquidity and Capital Resources



As of September 30, 2003, cash equivalents and short-term marketable securities were $115.7 million and we held $135.5 million of long-term investment
grade corporate and government securities.



Net cash provided
by operating activities was $46.9 million and $35.1 million for the nine months ended September 30, 2003 and 2002, respectively. The increase in cash from operating activities in the nine months ended September 30, 2003 was driven primarily by
strong cash collections as well as higher net income, depreciation expense, income taxes payable and deferred revenue.



We used $24.2 million in investing activities during the nine months ended September 30, 2003, consisting of $14.0 million net cash paid for purchases of
marketable securities, $5.4 million in capital expenditures and $4.7 million paid for acquisitions, net of cash acquired. Net cash used in investing activities was $19.5 million in the nine months ended September 30, 2002, consisting of $14.0
million net cash paid for purchases of marketable securities, $3.3 million in capital expenditures and $4.1 million paid for an



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acquisition, offset slightly by net proceeds of $1.9 million from the sale of an aircraft. Capital expenditures primarily consisted of information technology
hardware and software purchases.



Financing activities
generated $8.4 million and $4.5 million in the nine months ended September 30, 2003 and 2002, respectively, primarily from issuance of our common stock under the employee stock purchase plan and employee stock option program.



In December 2000, our Board of Directors authorized a stock repurchase
program under which we may purchase up to two million shares of our common stock. Under the repurchase program, we may purchase shares from time to time at varying prices in open market or private transactions. 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. As of September 30, 2003, we had repurchased approximately 1.7 million shares of our common stock
under this program for an aggregate cost of approximately $58.0 million. Repurchases help offset dilution from stock issued under our employee stock option and employee stock purchase plans. No shares of common stock were repurchased under this plan
during the nine months ended September 30, 2002 or 2003.



As of
September 30, 2003, our significant contractual obligations or commercial commitments include our facility lease commitments and operating leases for office facilities and certain items of equipment, and the remaining balance of certain indebtedness
assumed in connection with our acquisition of FastLane in September 2000. These commitments will require cash payments of $14.9 million in 2003, $10.9 million in 2004, $9.8 million in 2005, $6.6 million in 2006 and $5.2 million thereafter. In
addition, we have committed to make additional capital contributions to a private equity fund totaling $1.7 million as capital calls are made. We do not have any off-balance sheet arrangements that could reduce our liquidity.



In connection with our acquisitions of Sitraka, eCritical and Discus Data:



Sitraka  We agreed to pay up to $3.6 million of
contingent consideration to the former principal shareholders of Sitraka, dependent upon receipt or application of a variety of certain tax refunds and tax credits within an 18 month period following the acquisition date. Tax refunds and credits in
the aggregate amount of $3.0 million were received by September 30, 2003, and an equal amount of contingent consideration has been paid as of the date of this Report.



eCritical  We guaranteed payments of $0.2 million related to employment agreements with certain key employees during
the first year following the close of the acquisition. An additional non-guaranteed amount of up to $0.2 million may be earned in the two years following the acquisition if certain sales of eCritical products, based on a formula, exceed $1.0 million
following the close of the acquisition. As of September 30, 2003, no contingent consideration has been paid under this commitment.



Discus Data  We agreed to pay certain former shareholders guaranteed future consideration of $2.0 million no later than May 30, 2005. Payment of
$1.0 million of the future consideration is required to be paid earlier if the completion of certain deliverables is achieved and the remaining $1.0 million is required to be paid earlier if certain earn-out requirements are met. As of September 30,
2003, no contingent consideration has been paid under this commitment.



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 twelve months. If we are not able to generate or sustain positive cash flow from operations, we would be required to use existing cash, cash equivalents and investment balances to support our working capital. Our ability to
generate cash from operations is subject to substantial risks described below under the caption Risk Factors.



Critical Accounting Policies and Estimates



The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States of America. 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 condensed consolidated financial statements.



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Revenue Recognition



We derive revenues from two primary sources: (1) software licenses and (2) services, which include customer support, consulting and education. We license
our products through our direct sales force and indirectly through resellers. We recognize revenue in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue
Recognition, and related interpretations, and SOP 98-9 Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Based on our reading and interpretation of SOP 97-2 and SOP 98-9, we
believe that our current sales contract terms and business arrangements have been properly reported. The AICPA and its Software Revenue Recognition Task Force continue to issue interpretations and guidance for applying the relevant standards to a
wide range of sales contract terms and business arrangements that are prevalent in the software industry. Also, the Securities and Exchange Commission (SEC) has issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, which provides guidance related to revenue recognition based on interpretations and practices followed by the SEC. Future interpretations of existing accounting standards or changes in our business practices could
result in future changes in our revenue accounting policies that could have a material adverse effect on our business, financial condition and results of operations.



Revenues from sales of software licenses, which generally do not contain multiple elements, are recognized when: (1) we
enter into a legally binding arrangement with a customer; (2) we deliver the products; (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is probable. If all the
requirements of SOP 97-2, SOP 98-9 and SAB 101 have not been met, revenue recognition is deferred until such items are known or resolved. Revenue from post-sale customer support is deferred and recognized ratably over the term of the support
contract. Revenues from consulting and training services are recognized as the services are performed.



For arrangements with multiple elements, we allocate revenue to each element of a transaction based upon its fair value as determined in reliance on
vendor-specific objective evidence. Vendor-specific objective evidence of fair value for all elements of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately. If
we cannot objectively determine the fair value of any undelivered element included in bundled software and service arrangements, we defer revenue until all elements are delivered, services have been performed or until fair value can objectively be
determined. When the fair value of a delivered element has not been established, we use the residual method to record revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered
elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue.



Accounts Receivable



We maintain allowances for sales returns and doubtful accounts for estimated losses resulting from the unwillingness or 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. 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. Additionally, if significant product performance issues were to arise resulting in our
accepting sales returns, additional allowances may be required which would result in a reduction of revenue in the period such determination was made. Our standard licensing agreement does not permit customers to return products except in situations
where the product does not perform in accordance with established product requirements and we are unable to remedy the outstanding issues. While such amounts 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



In
July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other
intangible assets. We adopted SFAS No. 141 at the beginning of the third quarter of 2001 and adopted SFAS No. 142 at the beginning of the first quarter of 2002. As required by SFAS No. 142, we discontinued amortizing the remaining balances of
goodwill as of the beginning of fiscal 2002. As a result, our annual amortization expense decreased approximately $56.0 million. All remaining and future acquired goodwill will be subject to impairment tests annually, or earlier if indicators of
potential impairment exist, using a fair-value-based approach. All other intangible assets will continue to be amortized over their estimated useful lives and assessed for impairment under SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.



Under SFAS No. 142,
goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. In conjunction with the implementation of SFAS No. 142, we performed our initial annual impairment review in the fourth quarter of
2002 and as a result determined that the carrying value of goodwill was less than the estimated fair value. In calculating the fair value of the reporting units (licenses and services), the Market Approach (Guideline Company Method) was the
methodology deemed the most reliable and used for impairment analysis. We will perform subsequent annual impairment reviews during the fourth



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quarter of each year, or earlier if indicators of potential impairment exist. Future impairment reviews may result in charges against earnings to write down
the value of goodwill.



Purchased intangible assets are
recorded at the appraised value and amortized using the straight-line method over estimated useful lives of two to seven years. The net carrying amount of purchased intangible assets was considered recoverable at September 30, 2003. We will continue
to evaluate the value of our purchased intangible assets on a periodic basis. Recoverability of these assets is determined based upon the forecasted undiscounted future net cash flows from the operations to which the assets relate, utilizing our
best estimates, appropriate assumptions and projections at the time. These projected future cash flows may significantly vary over time as a result of increased competition, changes in technology, and fluctuations in demand. 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 is 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.



Recently Issued Accounting Pronouncements



In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has
issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. We adopted the disclosure provisions of FIN 45 during the fourth quarter of
fiscal 2002 and we provided the required disclosures in Note 11 of the Notes to Condensed Consolidated Financial Statements. We adopted the recognition provisions of FIN 45 effective January 1, 2003 and such adoption did not have an
impact on our condensed consolidated results of operations or financial position.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods for voluntary transition to SFAS No. 123s fair value method of accounting for stock-based employee compensation (the fair value method). SFAS No. 148 also requires disclosure
of the effects of an entitys accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financial statements. We adopted the provisions of SFAS No. 148
effective January 1, 2003 and have provided the disclosures required under SFAS No. 148 in Note 2 of the Notes to Condensed Consolidated Financial Statements. Adoption of SFAS No. 148 did not have an adverse impact on our
consolidated results of operations and financial position since we have not adopted the fair value method. However, should we be required to adopt the fair value method in the future, such adoption could have a material impact on our consolidated
results of operations or financial position.



In January 2003,
the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. We adopted the provisions of FIN 46 effective January 1, 2003. We do not have any variable interest entities; thus, adoption of FIN 46 did not have an impact on our consolidated
results of operations and financial position.



In April 2003,
the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging. The statement requires that contracts with comparable characteristics be accounted for similarly and clarifies when
a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging
relationships designated after June 30,



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2003. We adopted SFAS No. 149 effective July 1, 2003 and such adoption did not have an impact on our condensed consolidated results of operations or
financial position.



In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain
financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument
embodies an obligation of the issuer. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We
adopted SFAS No. 150 effective July 1, 2003 and such adoption did not have an impact on our condensed consolidated results of operations or financial position because we have not issued any of these types of financial instruments.



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RISK FACTORS



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



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



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 discretionary nature of our customers purchasing decisions and budget cycles;
| | - | ----------------------------------------------------------------------------------



| |  | 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;
| | - | ----------------------------------------------------------------------------



| |  | 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;
| | - | --------------------------------------------------------------------------------------------



| |  | the unpredictability of the timing and level of sales through our indirect sales channels;
| | - | ------------------------------------------------------------------------------------------



| |  | costs related to acquisitions of technologies or businesses, including amortization costs for intangible assets with indefinite lives; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | the timing of releases of new versions of third-party software products that our products support or with which our products compete.
| | - | -------------------------------------------------------------------------------------------------------------------------------------



Fluctuations in our results of operations are likely to affect the market
price of our common stock and may not be related to or indicative of 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.



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General economic conditions and reduced levels of 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 continued 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. If these economic conditions do not improve, or we experience continued deterioration in general economic conditions
or further reduced corporate IT spending, our business and operating results could continue to 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 Quest Central for Oracle, and our Oracle development and deployment tools, 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 is derived from products that
specifically support Oracle-based products. If Oracle for any reason decides to promote technologies and standards that are not compatible with our technology, or if Oracle loses market share for its database products, our business, operating
results and financial condition would be materially adversely affected.



Many of our products are vulnerable to direct competition from Oracle



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



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



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



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



We have in the past made and we expect to
continue to make acquisitions of complementary companies, products or technologies, including our acquisition of Sitraka, Inc. in November 2002. Any additional acquisitions will require us 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 use cash, incur debt or issue equity securities to pay for any future acquisitions. Use of cash or debt may affect our liquidity and use of cash would reduce our cash reserves. 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 intangible assets with indefinite useful
lives. In consummating acquisitions, we are also subject to risks of entering geographic and business markets in which we have no or limited prior experience. Also, we may determine that the acquired company, product or technology does not further
our business strategy or that the company, product or technology is ultimately worth less than the price we paid, either of which could generate a future impairment charge. 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 efforts to constrain costs may strain our management, administrative, operational and financial infrastructure



We are experiencing slower growth and are focused on increasing our operating margins. These efforts place a strain on our management, administrative,
operational and financial infrastructure. Our ability to manage our operations while reducing operating costs requires us to continue to improve our operational, financial and management controls and reporting systems and procedures. Although we
achieved a year over year increase in our margins from fiscal 2001 to 2002, there can be no guarantees that we will be successful in achieving our profitability targets in any future quarterly or annual period.



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 expose us to certain risks



We continue to expand our international sales activities as part of our
business strategy. As a result, we face increasing risks from our international operations, 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;
| | - | ----------------------------------



| |  | political unrest or terrorism, particularly in areas in which we have facilities;
| | - | ---------------------------------------------------------------------------------



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



| |  | licenses, tariffs and other trade barriers.
| | - | -------------------------------------------



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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 limited experience in developing localized versions of our products and marketing and distributing them internationally.



Our operating results may be affected if we are required to change our accounting for
employee stock options



We currently account for the
issuance of stock options under APB Opinion No. 25, Accounting for Stock Issued to Employees. Under APB No. 25, no compensation expense is recognized for options granted to employees where the exercise price equals the market price of
the underlying stock on the date of grant. Certain proposals related to treating the grant of an employee stock option as an expense are currently under consideration by accounting standards organizations and governmental authorities. If such
proposals are adopted and we are required to change the way we account for stock options, our operating results could be negatively impacted as a result of the additional expenses associated with stock options. See Note 2 of the Notes to
Condensed Consolidated Financial Statements for a more detailed presentation of our accounting for stock-based compensation plans.



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. 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.



Failure to adequately protect our intellectual property rights 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 generally rely on a
combination of trademark, trade secret, patent, 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, whether successful or unsuccessful, could result in substantial costs and diversion of management and financial resources, which could harm our business.



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.



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Third parties may claim that our software products or services infringe on their intellectual property rights,
exposing us to litigation that, regardless of merit, may be costly to defend



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 that our current or future products infringe their
intellectual property rights. Any such claim, with or without merit, could have a significant effect on our business and financial results. See Legal Proceedings in Part II, Item 1, of this report, for information concerning
copyright infringement and trade secret misappropriation claims initiated against Quest by Computer Associates International, Inc. This and any future third party claim could be time consuming, divert managements attention from our business
operations and result in substantial litigation costs, including any monetary damages and customer indemnification obligations, which may result from such claims. In addition, parties making these claims may be able to obtain injunctive or other
equitable relief affecting our ability to license the products that incorporate the challenged intellectual property. As a result of such claims, we may be required to obtain licenses from third parties, develop alternative technology or redesign
our products. We cannot be sure that such licenses would be available on terms acceptable to us, if at all. If a successful claim is made against us and we are unable to develop or license alternative technology, our business and financial results
and position could be materially adversely affected.



Our business will
suffer if our software contains errors



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



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



| |  | loss of customers;
| | - | ------------------



| |  | damage to our reputation;
| | - | -------------------------



| |  | failure to achieve market acceptance;
| | - | -------------------------------------



| |  | diversion of development resources;
| | - | -----------------------------------



| |  | increased service and warranty costs;
| | - | -------------------------------------



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



| |  | increased insurance costs.
| | - | --------------------------



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



We incorporate software licensed from third parties into some of our
products and any significant interruption in the availability of these third-party software products or defects in these products could reduce the demand for, or prevent the shipping of, our products



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.



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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, fires and similar events, as well as from power outages. We have in the past 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.



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 and services. The introduction of products embodying new technologies and the emergence of new industry standards can render our existing products
obsolete and unmarketable. As a result of the complexities inherent in todays computing environments and the performance demanded by customers for embedded databases and Web-based products, new products and product enhancements can require
long development and testing periods. As a result, significant delays in the general availability of such new releases or significant problems in the installation or implementation of such new releases could have a material adverse effect on our
business, operating results and financial condition. We may not be successful in:



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



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



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



We may not be able to attract and retain personnel



Our future success depends on the continued service of our executive officers and other key administrative, sales and marketing and support personnel,
many of whom have recently joined our company. In addition, the success of our business is substantially dependent on the services of our Chief Executive Officer and 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 3: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.



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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. Based on our overall currency rate exposure at September 30, 2003, a ten percent change in currency rates would not have a material effect on our consolidated financial position, results of
operations or cash flows. 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 and benefits 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 interest-rate risk relates primarily to our investment portfolio. We have not used derivative financial instruments to hedge the
market risks of our investments. 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 investment-grade bonds and United States government and agency securities. Investments purchased with an original maturity of three months or less are considered to be cash equivalents. We classify all of our
investments as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of shareholders equity.



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



|                                      |  | AmortizedBook Value |         | WeightedAverage Rate |     
|------------------------------------- |  | ------------------- | ------- | -------------------- | ----
|Investments maturing by September 30, |  |                     |         |                      |     
|2004                                  |  | $                   | 115,532 |                      | 1.70
|2005                                  |  |                     | 19,509  |                      | 4.52
|2006                                  |  |                     | 29,969  |                      | 2.41
|2007                                  |  |                     | 30,000  |                      | 2.58
|Thereafter                            |  |                     | 55,313  |                      | 4.16
|                                      |  |                     |         |                      |     
|Total portfolio                       |  | $                   | 250,323 |                      | 2.65
|                                      |  |                     |         |                      |     



We 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 4:Controls and Procedures



Evaluation
of disclosure controls and procedures:



Our management,
with the participation of the chief executive officer and chief financial officer, has performed an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on
such evaluation, our chief executive officer and chief financial officer concluded that, as of September 30, 2003, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we
file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms and that such information is accumulated and communicated to our management as
appropriate to allow timely decisions regarding required disclosure.



Internal control over financial reporting:



During the period covered by this report, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.



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PART IIOTHER INFORMATION



Item 1:Legal Proceedings



On
July 2, 2002, Computer Associates International, Inc. (CA) filed a complaint against us and four of our employees in the U.S. District Court for the Northern District of Illinois alleging copyright infringement and trade secret misappropriation in
connection with our development of the database administration component of our Quest Central for DB2 product and seeking injunctive relief and unspecified money damages. The complaint was amended in May 2003 to add another Quest employee as a
defendant and to assert breach of contract claims against three of the individual defendants. In October 2003, CA filed a motion for preliminary injunction. A ruling on this motion is not expected until late in the first quarter of 2004. If granted,
we would be preliminarily enjoined from licensing Quest Central for DB2. We will vigorously defend CAs claims and do not believe that this matter will have a material adverse effect on our results of operations or financial condition.



After we announced on July 23, 2003 that we would restate
certain financial results as a result of our discovery of a computational error relating to foreign currency conversions, numerous separate complaints purporting to be class actions were filed in the United States District Court for the Central
District of California alleging that we and some of our officers and directors violated provisions of the Securities Exchange Act of 1934. The complaints contain varying allegations, including that we made materially false and misleading statements
with respect to our financial results for 2002 and the quarter ended March 31, 2003 included in our filings with the SEC, press releases and other public disclosures. Orders designating a lead plaintiff and consolidating the federal class action
complaints were issued by the U. S. District Court in late October 2003, and an amended consolidated class action complaint is expected to be filed late in the fourth quarter of 2003. In addition, one complaint purporting to be a derivative action
has been filed in California state court against some of our directors and officers. This complaint is based on the same facts and circumstances described in the class action complaints and generally alleges that the named directors and officers
breached their fiduciary duties by failing to oversee adequately our financial reporting. All of the complaints generally seek an unspecified amount of damages. The cases are in the very preliminary stages and we will vigorously defend these claims;
however, it is not possible for us to quantify the extent of our potential liability, if any. An unfavorable outcome in any of these cases could have a material adverse effect on our business, financial condition, results of operations and cash
flow. In addition, defending any litigation may be costly and divert managements attention from the day-to-day operations of our business.



We are a party to other litigation, which we consider to be routine and incidental to our business. Management does not expect the results of any of these
actions to have a material adverse effect on our results of operations or financial condition.



Item 6:Exhibits and Reports on Form 8-K



(a) EXHIBITS



|ExhibitNumber |  | Exhibit Title                                                                                                                                     
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|              | 
|31.1          |  | Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended                        
|              | 
|31.2          |  | Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended                        
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



(b) REPORTS ON FORM 8-K



On July 23, 2003, we filed a Current Report on Form 8-K furnishing the press
release announcing our operating results for the quarter ended June 30, 2003.



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SIGNATURES



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



QUEST SOFTWARE, INC./s/    M. BRINKLEY MORSEM. Brinkley MorseVice President, Finance and Operations and Chief Financial Officer


November 13, 2003

/s/    KEVIN E. BROOKSKevin E. Brooks Principal Accounting Officer




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