##### Table of Contents

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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 June 30, 2003

OR

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

For the transition period from __________ to __________

COMMISSION FILE NO. 000-26937

QUEST SOFTWARE, INC. (Exact name of registrant as specified in its charter)

|California                                                     |  | 33-0231678                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of 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 o
|----- | ----

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

|Yes x | No o
|----- | ----

The number of shares outstanding of the Registrants Common Stock, no par value, as of August 8, 2003 was 92,622,640.

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##### Table of Contents

QUEST SOFTWARE, INC.

FORM 10-Q

TABLE OF CONTENTS

|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | Page Number
|---------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|PART I.    | FINANCIAL INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                               |            
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 1.    | Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                |            
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | Condensed Consolidated Balance Sheets as of December 31, 2002 and June 30, 2003 (unaudited)*                                                                                                                                                                                                                                                                                                                                                                        | 2          
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | Condensed Consolidated Statements of Operations for the Three* and Six Months Ended June 30, 2002 and 2003 (unaudited)                                                                                                                                                                                                                                                                                                                                              | 3          
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | Condensed Consolidated Statements of Cash Flows for the Three* and Six Months Ended June 30, 2002 and 2003 (unaudited)                                                                                                                                                                                                                                                                                                                                              | 4          
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | Condensed Consolidated Statements of Comprehensive Operations for the Three* and Six Months Ended June 30, 2002 and 2003 (unaudited)                                                                                                                                                                                                                                                                                                                                | 5          
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                                                                                                                                                                                                                                                                                                                                                    | 6          
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|           | * The Condensed Consolidated Balance Sheets as of December 31, 2002 and the Condensed Consolidated Statements of Operations, Statements of Cash Flows and Statements of Comprehensive
Operations for the Three Months ended June 30, 2002 have been restated as discussed in our Annual Report on Form 10-K/A for the year ended December 31, 2002 as filed August 14, 2003 and in Note 2 of Notes to Condensed Consolidated Financial
Statements contained herein. |            
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 2.    | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                                                                                                                                                                                                                                                               | 12         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 3.    | Quantitative and Qualitative Disclosures about Market Risks                                                                                                                                                                                                                                                                                                                                                                                                         | 24         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 4.    | Controls and Procedures                                                                                                                                                                                                                                                                                                                                                                                                                                             | 25         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|PART II.   | OTHER INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                                   |            
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 1.    | Legal Proceedings                                                                                                                                                                                                                                                                                                                                                                                                                                                   | 26         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 4.    | Submission of Matters to a Vote of Security Holders                                                                                                                                                                                                                                                                                                                                                                                                                 | 26         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|Item 6.    | Exhibits and Reports on Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                                                    | 27         
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            
|SIGNATURES | 28                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |            



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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         |         | June 30, 2003 |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | ------------- | -
|                                                                                                                                                     |  |                           |         |               |  
|                                                                                                                                                     |  | (As restated, see Note 2) |         |               |  
|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 5, 11 and 12)                                                                                                   |  |                           |         |               |  
|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 92,226 issued and outstanding at December 31, 2002 and June 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.

2



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

|                                            |  | Three Months Ended June 30, |        | Six Months Ended June 30, |  
|------------------------------------------- |  | --------------------------- | ------ | ------------------------- | -
|                                            |  |                             |        |                           |  
|                                            |  | 2002                        |        | 2003                      |  
|                                            |  |                             |        |                           |  
|                                            |  | (As restated, see Note 2)   |        |                           |  
|Revenues:                                   |  |                             |        |                           |  
|Licenses                                    |  | $                           | 38,999 |                           | $
|Services                                    |  |                             | 22,891 |                           |  
|                                            |  |                             |        |                           |  
|Total revenues                              |  |                             | 61,890 |                           |  
|Cost of revenues:                           |  |                             |        |                           |  
|Licenses                                    |  |                             | 1,002  |                           |  
|Services                                    |  |                             | 4,593  |                           |  
|Amortization of purchased intangible assets |  |                             | 1,289  |                           |  
|                                            |  |                             |        |                           |  
|Total cost of revenues                      |  |                             | 6,884  |                           |  
|                                            |  |                             |        |                           |  
|Gross profit                                |  |                             | 55,006 |                           |  
|Operating expenses:                         |  |                             |        |                           |  
|Sales and marketing                         |  |                             | 31,583 |                           |  
|Research and development                    |  |                             | 15,091 |                           |  
|General and administrative                  |  |                             | 6,331  |                           |  
|Amortization of purchased intangible assets |  |                             | 480    |                           |  
|                                            |  |                             |        |                           |  
|Total operating expenses                    |  |                             | 53,485 |                           |  
|                                            |  |                             |        |                           |  
|Income from operations                      |  |                             | 1,521  |                           |  
|Other income, net                           |  |                             | 3,707  |                           |  
|Write-down of investments                   |  |                             | (1,095 | )                         |  
|                                            |  |                             |        |                           |  
|Income before income tax provision          |  |                             | 4,133  |                           |  
|Income tax provision                        |  |                             | 1,718  |                           |  
|                                            |  |                             |        |                           |  
|Net income                                  |  | $                           | 2,415  |                           | $
|                                            |  |                             |        |                           |  
|Net income per share:                       |  |                             |        |                           |  
|Basic and diluted                           |  | $                           | 0.03   |                           | $
|Weighted average shares:                    |  |                             |        |                           |  
|Basic                                       |  |                             | 90,323 |                           |  
|Diluted                                     |  |                             | 92,577 |                           |  

---

|* | Includes restated amounts for the three months ended March 31, 2003.
|- | --------------------------------------------------------------------

See accompanying
notes to condensed consolidated financial statements.

3



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QUEST SOFTWARE, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)

|                                                                                  |  | Six Months Ended June 30,  |        
|--------------------------------------------------------------------------------- |  | -------------------------- | -------
|                                                                                  |  |                            |        
|                                                                                  |  | 2002                       |        
|                                                                                  |  |                            |        
|                                                                                  |  | (As restated,  see Note 2) |        
|Cash flows from operating activities:                                             |  |                            |        
|Net income                                                                        |  | $                          | 4,305  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                            |        
|Depreciation and amortization                                                     |  |                            | 10,704 
|Compensation expense associated with stock option grants                          |  |                            | 809    
|Accrued interest receivable from shareholders                                     |  |                            | (629   
|Deferred income taxes                                                             |  |                            | 1,060  
|Provision for bad debts                                                           |  |                            | 382    
|Write-down of investments                                                         |  |                            | 1,095  
|Changes in operating assets and liabilities, net of effects of acquisitions:      |  |                            |        
|Accounts receivable                                                               |  |                            | 6,907  
|Prepaid expenses and other current assets                                         |  |                            | (805   
|Other assets                                                                      |  |                            | 942    
|Accounts payable                                                                  |  |                            | (1,760 
|Accrued compensation                                                              |  |                            | 614    
|Other accrued expenses                                                            |  |                            | (3,767 
|Income taxes payable                                                              |  |                            | 2,387  
|Deferred revenue                                                                  |  |                            | 3,039  
|Other liabilities                                                                 |  |                            | (672   
|                                                                                  |  |                            |        
|Net cash provided by operating activities                                         |  |                            | 24,611 
|Cash flows from investing activities:                                             |  |                            |        
|Purchases of property and equipment                                               |  |                            | (2,446 
|Cash paid for acquisition, net of cash acquired                                   |  |                            | (4,063 
|Purchases of marketable securities                                                |  |                            | (44,349
|Sales and maturities of marketable securities                                     |  |                            | 22,187 
|                                                                                  |  |                            |        
|Net cash (used in) provided by investing activities                               |  |                            | (28,671
|Cash flows from financing activities:                                             |  |                            |        
|Repayment of notes payable                                                        |  |                            | (223   
|Repayment of capital lease obligations                                            |  |                            | (125   
|Proceeds from the exercise of stock options                                       |  |                            | 1,131  
|Proceeds from employee stock purchase plan                                        |  |                            | 2,522  
|                                                                                  |  |                            |        
|Net cash provided by financing activities                                         |  |                            | 3,305  
|Effect of exchange rate changes on cash and cash equivalents                      |  |                            | (412   
|                                                                                  |  |                            |        
|Net (decrease) increase in cash and cash equivalents                              |  |                            | (1,167 
|Cash and cash equivalents, beginning of period                                    |  |                            | 30,279 
|                                                                                  |  |                            |        
|Cash and cash equivalents, end of period                                          |  | $                          | 29,112 
|                                                                                  |  |                            |        
|Supplemental disclosures of condensed consolidated cash flow information:         |  |                            |        
|Cash paid for:                                                                    |  |                            |        
|Interest                                                                          |  | $                          | 91     
|                                                                                  |  |                            |        
|Income taxes                                                                      |  | $                          | 349    
|                                                                                  |  |                            |        
|Supplemental schedule of non-cash investing and financing activities:             |  |                            |        
|Unrealized gain (loss) on available-for-sale securities                           |  | $                          | 805    
|                                                                                  |  |                            |        
|Tax benefit related to stock option exercises                                     |  | $                          | 2,930  
|                                                                                  |  |                            |        

---

|* | Includes restated amounts for the three months ended March 31, 2003.
|- | --------------------------------------------------------------------

See Note 5 for
details of assets acquired and liabilities assumed in purchase transactions.

See accompanying notes to condensed consolidated financial statements.

4



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QUEST SOFTWARE, INC.CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (In thousands) (Unaudited)

|                                                        |  | Three Months Ended June 30, |                           | Six Months Ended June 30, |  
|------------------------------------------------------- |  | --------------------------- | ------------------------- | ------------------------- | -
|                                                        |  |                             |                           |                           |  
|                                                        |  | 2002                        |                           | 2003                      |  
|                                                        |  |                             |                           |                           |  
|                                                        |  |                             | (As restated, see Note 2) |                           |  
|Net income                                              |  | $                           | 2,415                     |                           | $
|Other comprehensive income:                             |  |                             |                           |                           |  
|Unrealized gain (loss) on available-for-sale securities |  |                             | 1,652                     |                           |  
|                                                        |  |                             |                           |                           |  
|Comprehensive income                                    |  | $                           | 4,067                     |                           | $
|                                                        |  |                             |                           |                           |  

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|* | Includes restated amounts for the three months ended March 31, 2003.
|- | --------------------------------------------------------------------

See accompanying
notes to condensed consolidated financial statements.

5



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##### Table of Contents

QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

Our accompanying unaudited condensed consolidated financial statements as of June 30, 2003 and for the three and six months ended June 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.

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, and our unaudited condensed consolidated financial statements included in our Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2003, as amended.

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

Certain reclassifications have been
made to the June 30, 2002 balances in order to conform to the June 30, 2003 presentation.

2. Restatement

Subsequent to the issuance of our condensed consolidated financial statements as of and for the three months ended March 31, 2003, we restated our financial
statements to correct computational errors in translating property and equipment and deferred revenue balances of foreign subsidiaries into U.S. Dollars. Under Statement of Financial Accounting Standard (SFAS) No. 52, Accounting
for Foreign Currency Translation, certain balance sheet and income statement accounts require translation of account balances of foreign subsidiaries from foreign currencies into the US Dollar using historical rates because the functional
currency of the foreign subsidiary is the US Dollar. Historical rates are defined as the rates in effect in the month that the transaction was originally recorded. Because of an error in the method used to translate these foreign-currency
denominated accounts into U.S. Dollars we did not use historical rates correctly to translate foreign-currency denominated property and equipment and deferred revenue accounts into US Dollars at historical rates, the related balance sheet and
statements of operations accounts required correction.

The condensed consolidated financial data set forth below presents our condensed
consolidated statements of operations for the three and six months ended June 30, 2002 and our condensed consolidated balance sheets as of June 30, 2002 on a comparative basis showing the amounts as previously reported and as restated. We have also
restated our consolidated balance sheet as of December 31, 2002 included in our Annual Report of Form 10-K for the year ended December 31, 2002, as amended.

CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS(In thousands, except per share data) (Unaudited)

|                                                                                       |  | Three Months Ended June 30, 2002 |        |   | Six Months Ended June 30, 2002 |  
|-------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------ | -
|                                                                                       |  | (As Reported)(1)                 |        |   | (As Restated)                  |  
|Revenues:                                                                              |  |                                  |        |   |                                |  
|Licenses                                                                               |  | $                                | 39,689 |   |                                | $
|Services                                                                               |  |                                  | 23,848 |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Total revenues                                                                         |  |                                  | 63,537 |   |                                |  
|Cost of revenues:                                                                      |  |                                  |        |   |                                |  
|Licenses                                                                               |  |                                  | 1,002  |   |                                |  
|Services                                                                               |  |                                  | 4,593  |   |                                |  
|Amortization of purchased intangible assets                                            |  |                                  | 1,289  |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Total cost of revenues                                                                 |  |                                  | 6,884  |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Gross profit                                                                           |  |                                  | 56,653 |   |                                |  
|Operating expenses:                                                                    |  |                                  |        |   |                                |  
|Sales and marketing                                                                    |  |                                  | 31,583 |   |                                |  
|Research and development                                                               |  |                                  | 15,091 |   |                                |  
|General and administrative                                                             |  |                                  | 6,184  |   |                                |  
|Amortization of purchased intangible assets                                            |  |                                  | 480    |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Total operating expenses                                                               |  |                                  | 53,338 |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Income from operations                                                                 |  |                                  | 3,315  |   |                                |  
|Other income, net                                                                      |  |                                  | 2,275  |   |                                |  
|Write-down of investments                                                              |  |                                  | (1,095 | ) |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Income before income taxes                                                             |  |                                  | 4,495  |   |                                |  
|Income tax provision                                                                   |  |                                  | 1,823  |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Net income                                                                             |  | $                                | 2,672  |   |                                | $
|                                                                                       |  |                                  |        |   |                                |  
|Net income per share:                                                                  |  |                                  |        |   |                                |  
|Basic and Diluted                                                                      |  | $                                | 0.03   |   |                                | $
|                                                                                       |  |                                  |        |   |                                |  
|Weighted average shares:                                                               |  |                                  |        |   |                                |  
|Basic                                                                                  |  |                                  | 90,323 |   |                                |  
|Diluted                                                                                |  |                                  | 92,577 |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Net income                                                                             |  |                                  | 2,672  |   |                                |  
|Other comprehensive loss:                                                              |  |                                  |        |   |                                |  
|Unrealized loss on available for sale securities                                       |  |                                  | 1,651  |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|Comprehensive income                                                                   |  |                                  | 4,323  |   |                                |  
|                                                                                       |  |                                  |        |   |                                |  
|                                                                                      
|(1) Includes certain reclassifications primarily for compensation expense. See Note 6.



CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)



|                                                                                                                                                    |  | As of June 30, 2002 |        
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- | -------
|                                                                                                                                                    |  | (As Reported)       |        
|ASSETS                                                                                                                                              |  |                     |        
|Current assets:                                                                                                                                     |  |                     |        
|Cash and cash equivalents                                                                                                                           |  | $                   | 29,112 
|Short-term marketable securities available for sale                                                                                                 |  |                     | 19,240 
|Accounts receivable, net                                                                                                                            |  |                     | 28,561 
|Prepaid expenses and other current assets                                                                                                           |  |                     | 9,035  
|Deferred income taxes                                                                                                                               |  |                     | 11,025 
|                                                                                                                                                    |  |                     |        
|Total current assets                                                                                                                                |  |                     | 96,973 
|Property and equipment, net                                                                                                                         |  |                     | 52,245 
|Long-term marketable securities                                                                                                                     |  |                     | 180,387
|Goodwill, net                                                                                                                                       |  |                     | 195,958
|Amortizing intangible assets, net                                                                                                                   |  |                     | 10,622 
|Deferred income taxes                                                                                                                               |  |                     | 10,902 
|Other assets                                                                                                                                        |  |                     | 4,825  
|                                                                                                                                                    |  |                     |        
|Total assets                                                                                                                                        |  | $                   | 551,912
|                                                                                                                                                    |  |                     |        
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                |  |                     |        
|Current liabilities:                                                                                                                                |  |                     |        
|Accounts payable                                                                                                                                    |  | $                   | 3,826  
|Accrued compensation                                                                                                                                |  |                     | 13,622 
|Other accrued expenses                                                                                                                              |  |                     | 19,538 
|Income taxes payable                                                                                                                                |  |                     | 2,636  
|Deferred revenue                                                                                                                                    |  |                     | 53,772 
|                                                                                                                                                    |  |                     |        
|Total current liabilities                                                                                                                           |  |                     | 93,394 
|Long-term liabilities and other                                                                                                                     |  |                     | 5,458  
|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; 89,226 and 90,211 issued and outstanding at December 31, 2001 and June 30,
2002 respectively |  |                     | 544,203
|Accumulated deficit                                                                                                                                 |  |                     | (74,580
|Accumulated other comprehensive income (loss)                                                                                                       |  |                     | 1,328  
|Notes receivable from sale of common stock                                                                                                          |  |                     | (17,891
|                                                                                                                                                    |  |                     |        
|Total shareholders equity                                                                                                                          |  |                     | 453,060
|                                                                                                                                                    |  |                     |        
|Total liabilities and shareholders equity                                                                                                          |  | $                   | 551,912
|                                                                                                                                                    |  |                     |        

|   
|---
|(1)

3. 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 and 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 12. 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, 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 and earnings 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 herein. Adoption of SFAS No. 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 No. 123, as
amended by SFAS No. 148, we have chosen to continue to account for our stock-based compensation plans under APB Opinion No. 25 and provide the expanded disclosures specified in SFAS No. 123, as amended by SFAS No. 148. Had 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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##### Table of Contents

|                                                                                                                           |  | Three Months Ended June 30, |        | Six Months Ended June 30, |  
|-------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | ------------------------- | -
|                                                                                                                           |  |                             |        |                           |  
|                                                                                                                           |  | 2002                        |        | 2003                      |  
|                                                                                                                           |  |                             |        |                           |  
|Net income:                                                                                                                |  |                             |        |                           |  
|As reported                                                                                                                |  | $                           | 2,415  |                           | $
|Add: Stock-based compensation expense included in reported net income, net of related tax effects                          |  |                             | (34    | )                         |  
|Deduct: Total stock-based compensation determined under fair value based method for all awards, net of related tax effects |  |                             | (5,813 | )                         |  
|                                                                                                                           |  |                             |        |                           |  
|Pro forma                                                                                                                  |  | $                           | (3,432 | )                         | $
|                                                                                                                           |  |                             |        |                           |  
|Basic and diluted net income per share:                                                                                    |  |                             |        |                           |  
|As reported                                                                                                                |  |                             | 0.03   |                           |  
|Pro forma                                                                                                                  |  |                             | (0.04  | )                         |  

For purposes of estimating the compensation cost
of our option grants in accordance with SFAS No. 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 six
months ended June 30, 2002 and 2003 were as follows:

|                          |  | Three Months Ended June 30, |     | Six Months Ended June 30, | 
|------------------------- |  | --------------------------- | --- | ------------------------- | 
|                          |  |                             |     |                           | 
|                          |  | 2002                        |     | 2003                      | 
|                          |  |                             |     |                           | 
|Risk-free interest rates  |  |                             | 5%  |                           | 
|Expected life (in years)  |  |                             | 5   |                           | 
|Expected stock volatility |  |                             | 83% |                           | 

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, 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, 2003.  We do not expect that the adoption of this standard will have
a material effect on our 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. SFAS No. 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 do not
expect that the adoption of this standard will have a material effect on our consolidated results of operations or financial position because we have not issued any of these types of financial instruments.

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4. Amortizing Intangible Assets

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

|                      |  | December 31, 2002     |        |                          |   |         |   | June 30,  2003                       |       
|--------------------- |  | --------------------- | ------ | ------------------------ | - | ------- | - | ------------------------------------ | ------
|                      |  |                       |        |                          |   |         |   |                                      |       
|                      |  | Gross Carrying Amount |        | Accumulated Amortization |   | Net     |   | Weighted Average Amortization Period |       
|                      |  |                       |        |                          |   |         |   |                                      |       
|Acquired technology   |  | $                     | 44,017 |                          | $ | (18,785 | ) | $                                    | 25,232
|Customer list         |  |                       | 5,101  |                          |   | (1,945  | ) |                                      | 3,156 
|Non-compete agreement |  |                       | 2,200  |                          |   | (1,008  | ) |                                      | 1,192 
|Trademark             |  |                       | 1,450  |                          |   | (48     | ) |                                      | 1,402 
|Other                 |  |                       | 2,264  |                          |   | (2,130  | ) |                                      | 134   
|                      |  |                       |        |                          |   |         |   |                                      |       
|                      |  | $                     | 55,032 |                          | $ | (23,916 | ) | $                                    | 31,116
|                      |  |                       |        |                          |   |         |   |                                      |       

Amortization expense for amortizing intangible
assets was $3.3 million and $6.3 million for the three and six months ended June 30, 2003, respectively. Estimated amortization expense related to intangible assets acquired prior to June 30, 2003 is $6.0 million for the remainder of fiscal 2003,
and $6.4 million, $4.7 million, $4.4 million, $3.7 million and $4.2 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.

5. Acquisitions

On April 3, 2003, we acquired the outstanding shares of eCritical Inc.
(eCritical), a provider of performance management solutions for network-enabled applications. eCriticals products will extend our software monitoring solutions beyond the internal firewall to enable information technology
(IT) administrators to monitor end user application response times and will 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, 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. 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 to collateralize 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. 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 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 million and $9 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.

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 six months ended June 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 Ended June 30, |        | Six Months Ended June 30, |  
|-------------------------------------- |  | --------------------------- | ------ | ------------------------- | -
|                                       |  |                             |        |                           |  
|                                       |  | 2002                        |        | 2003                      |  
|                                       |  |                             |        |                           |  
|Revenues                               |  | $                           | 65,911 |                           | $
|Net income                             |  |                             | 129    |                           |  
|Net income per sharebasic and diluted |  | $                           | 0.00   |                           | $

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

|                                                         |  | Licenses |         | Services |   | Total  | 
|-------------------------------------------------------- |  | -------- | ------- | -------- | - | ------ | 
|                                                         |  |          |         |          |   |        | 
|Balance as of December 31, 2002                          |  | $        | 176,105 |          | $ | 55,612 | 
|Goodwill acquired during six months ended June 30, 2003: |  |          |         |          |   |        | 
|eCritical                                                |  |          | 1,562   |          |   |       | 
|Discus                                                   |  |          | 4,427   |          |   | 1,398  | 
|Goodwill adjustment for Sitraka severance costs          |  |          | 449     |          |   | 142    | 
|                                                         |  |          |         |          |   |        | 
|Balance as of June 30, 2003                              |  | $        | 182,543 |          |   | 57,152 | 
|                                                         |  |          |         |          |   |        | 



6. 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.

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The following table shows the allocation to Cost of Licenses Revenues, Cost of Services Revenues, Sales and
Marketing, Research and Development, and General and Administrative expenses of such costs based on the related headcount for the three and six months ended June 30, 2002 and 2003 (in thousands):

|                               |  | Three Months Ended June 30, |     | Six Months Ended  June 30, |  
|------------------------------ |  | --------------------------- | --- | -------------------------- | -
|                               |  |                             |     |                            |  
|                               |  | 2002                        |     | 2003                       |  
|                               |  |                             |     |                            |  
|Cost of licenses revenues      |  | $                           |    |                            | $
|Cost of services revenues      |  |                             | (1  | )                          |  
|Sales and marketing            |  |                             | (14 | )                          |  
|Research and development       |  |                             | (39 | )                          |  
|General and administrative     |  |                             | (3  | )                          |  
|                               |  |                             |     |                            |  
|Total other compensation costs |  | $                           | (57 | )                          | $
|                               |  |                             |     |                            |  

We expect to amortize at least $0.3 million
per quarter throughout 2003, and insignificant amounts through 2004, which corresponds to the remaining vesting periods of the related options.

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. During the three months ended June 30, 2002, the reduction in other compensation cost associated with unvested awards that were forfeited exceeded the other compensation cost recognized for
other awards that continue to vest, resulting in a net decrease to other compensation cost.

7. 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 six months ended June 30, 2002 and 2003 (in thousands, except per share data):

|                                                                                     |  | Three Months Ended June 30, |        | Six Months Ended June 30, |  
|------------------------------------------------------------------------------------ |  | --------------------------- | ------ | ------------------------- | -
|                                                                                     |  |                             |        |                           |  
|                                                                                     |  | 2002                        |        | 2003                      |  
|                                                                                     |  |                             |        |                           |  
|Net income                                                                           |  | $                           | 2,415  |                           | $
|                                                                                     |  |                             |        |                           |  
|Basic net income per share  weighted average shares                                 |  |                             | 90,323 |                           |  
|Incremental common shares attributable to shares issuable under employee stock plans |  |                             | 2,254  |                           |  
|                                                                                     |  |                             |        |                           |  
|Diluted net income per share  weighted average shares                               |  |                             | 92,577 |                           |  
|                                                                                     |  |                             |        |                           |  
|Net income per share  basic and diluted                                             |  | $                           | 0.03   |                           | $
|                                                                                     |  |                             |        |                           |  

For the three and six months ended June 30, 2003, options to purchase 7,546 and 12,018 shares of common stock, respectively, with a weighted average price of $21.37 and $17.50, 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.

8. Shareholders Equity

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

9. Stock Option Plans

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

|                                                                                         |  | Number of Shares |        | Weighted-Average Exercise Price | 
|---------------------------------------------------------------------------------------- |  | ---------------- | ------ | ------------------------------- | 
|                                                                                         |  |                  |        |                                 | 
|Balance at December 31, 2002                                                             |  |                  | 19,710 |                                 | 
|Granted                                                                                  |  |                  | 1,080  |                                 | 
|Exercised                                                                                |  |                  | (1,025 | )                               | 
|Canceled                                                                                 |  |                  | (970   | )                               | 
|                                                                                         |  |                  |        |                                 | 
|Balance at June 30, 2003                                                                 |  |                  | 18,795 |                                 | 
|                                                                                         |  |                  |        |                                 | 
|Options exercisable as of June 30, 2003                                                  |  |                  | 5,792  |                                 | 
|                                                                                         |  |                  |        |                                 | 
|Weighted-average fair value of options granted during the six months ended June 30, 2003 |  |                  |        |                                 | 
|                                                                                         |  |                  |        |                                 | 

10. Geographic and Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by 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.

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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.

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

|                                 |  | Licenses |        | Services |   | Total  | 
|-------------------------------- |  | -------- | ------ | -------- | - | ------ | 
|                                 |  |          |        |          |   |        | 
|Three months ended June 30, 2002 |  |          |        |          |   |        | 
|Revenues                         |  | $        | 38,999 |          | $ | 22,891 | 
|Cost of Revenues                 |  |          | 2,291  |          |   | 4,593  | 
|                                 |  |          |        |          |   |        | 
|Gross profit                     |  | $        | 36,708 |          | $ | 18,298 | 
|                                 |  |          |        |          |   |        | 
|Three months ended June 30, 2003 |  |          |        |          |   |        | 
|Revenues                         |  | $        | 41,164 |          | $ | 29,671 | 
|Cost of Revenues                 |  |          | 3,501  |          |   | 5,343  | 
|                                 |  |          |        |          |   |        | 
|Gross profit                     |  | $        | 37,663 |          | $ | 24,328 | 
|                                 |  |          |        |          |   |        | 
|Six months ended June 30, 2002   |  |          |        |          |   |        | 
|Revenues                         |  | $        | 76,642 |          | $ | 44,839 | 
|Cost of Revenues                 |  |          | 4,612  |          |   | 8,963  | 
|                                 |  |          |        |          |   |        | 
|Gross profit                     |  | $        | 72,030 |          | $ | 35,876 | 
|                                 |  |          |        |          |   |        | 
|Six months ended June 30, 2003   |  |          |        |          |   |        | 
|Revenues                         |  | $        | 83,886 |          | $ | 58,148 | 
|Cost of Revenues                 |  |          | 6,563  |          |   | 10,538 | 
|                                 |  |          |        |          |   |        | 
|Gross profit                     |  | $        | 77,323 |          | $ | 47,610 | 
|                                 |  |          |        |          |   |        | 

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):

|                                 |  | North America (1) |         | Europe |   | Other International |   | Total |      
|-------------------------------- |  | ----------------- | ------- | ------ | - | ------------------- | - | ----- | -----
|                                 |  |                   |         |        |   |                     |   |       |      
|Three months ended June 30, 2002 |  |                   |         |        |   |                     |   |       |      
|Revenues                         |  | $                 | 45,062  |        | $ | 14,860              |   | $     | 1,968
|Gross profit                     |  |                   | 45,164  |        |   | 9,235               |   |       | 607  
|Income (loss) from operations    |  |                   | 1,899   |        |   | (598                | ) |       | 220  
|Long-lived assets                |  |                   | 451,549 |        |   | 1,958               |   |       | 1,280
|Three months ended June 30, 2003 |  |                   |         |        |   |                     |   |       |      
|Revenues                         |  | $                 | 51,093  |        | $ | 17,393              |   | $     | 2,349
|Gross profit                     |  |                   | 48,135  |        |   | 13,432              |   |       | 424  
|Income (loss) from operations    |  |                   | 1,549   |        |   | (7,349              | ) |       | 6,709
|Long-lived assets                |  |                   | 420,501 |        |   | 3,159               |   |       | 748  
|Six months ended June 30, 2002   |  |                   |         |        |   |                     |   |       |      
|Revenues                         |  | $                 | 91,567  |        | $ | 26,288              |   | $     | 3,626
|Gross profit                     |  |                   | 89,790  |        |   | 16,775              |   |       | 1,341
|Income (loss) from operations    |  |                   | 4,281   |        |   | (1,858              | ) |       | 513  
|Long-lived assets                |  |                   | 451,549 |        |   | 1,958               |   |       | 1,280
|Six months ended June 30, 2003   |  |                   |         |        |   |                     |   |       |      
|Revenues                         |  | $                 | 105,087 |        | $ | 32,702              |   | $     | 4,245
|Gross profit                     |  |                   | 104,454 |        |   | 19,364              |   |       | 1,115
|Income (loss) from operations    |  |                   | 7,754   |        |   | (14,274             | ) |       | 9,637
|Long-lived assets                |  |                   | 420,501 |        |   | 3,159               |   |       | 748  

---

(1) Principally represents operations in
the United States.

11. 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

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##### Table of Contents

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 June 30, 2003, we valued this cost basis investment at $1.0 million which included an additional capital contribution of $0.6 million during the quarter ended June 30, 2003. In addition, we have 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 or
for 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. During the three months ended June 30,
2002, we recorded a write down of $1.1 million associated with an other-than-temporary impairment of our venture capital investment. We do not believe that any impairment exists as of June 30, 2003.

12. 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. 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.  As of the time of filing of this report, these complaints have not yet been consolidated and neither a lead plaintiff nor lead counsel has been appointed.  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 six months ended June 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 development, report management and 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 all 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. Restatement

We have restated our condensed consolidated financial statements
for the year ended December 31, 2002 and three-and six-month periods ended June 30, 2002 to correct computational errors made in translating property and equipment and deferred revenue balances of foreign subsidiaries into U.S. Dollars. See
Note 2Restatement in the accompanying Notes to Condensed Consolidated Financial Statements for additional discussion regarding cause and effect of the computational errors and for a presentation of the impact of the
restatement on our condensed consolidated statements of operations for the three and six months ended June 30, 2002 and our condensed consolidated balance sheet as of June 30, 2002.

The following discussion reflects the effects of the restatement on our results of operations for the
three- and six-month periods ended June 30, 2002.

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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 Ended June 30, |       | Six Months Ended June 30, | 
|------------------------------------------- |  | --------------------------- | ----- | ------------------------- | 
|                                            |  |                             |       |                           | 
|                                            |  | 2002                        |       | 2003                      | 
|                                            |  |                             |       |                           | 
|Revenues:                                   |  |                             |       |                           | 
|Licenses                                    |  |                             | 63.0  | %                         | 
|Services                                    |  |                             | 37.0  |                           | 
|                                            |  |                             |       |                           | 
|Total revenues                              |  |                             | 100.0 |                           | 
|Cost of revenues:                           |  |                             |       |                           | 
|Licenses                                    |  |                             | 1.6   |                           | 
|Services                                    |  |                             | 7.4   |                           | 
|Amortization of purchased intangible assets |  |                             | 2.1   |                           | 
|                                            |  |                             |       |                           | 
|Total cost of revenues                      |  |                             | 11.1  |                           | 
|                                            |  |                             |       |                           | 
|Gross profit                                |  |                             | 88.9  |                           | 
|Operating expenses:                         |  |                             |       |                           | 
|Sales and marketing                         |  |                             | 51.0  |                           | 
|Research and development                    |  |                             | 24.4  |                           | 
|General and administrative                  |  |                             | 10.2  |                           | 
|Amortization of purchased intangible assets |  |                             | 0.8   |                           | 
|                                            |  |                             |       |                           | 
|Total operating expenses                    |  |                             | 86.4  |                           | 
|                                            |  |                             |       |                           | 
|Income from operations                      |  |                             | 2.5   |                           | 
|Other income, net                           |  |                             | 6.0   |                           | 
|Write-down of investments                   |  |                             | (1.8  | )                         | 
|                                            |  |                             |       |                           | 
|Income before income taxes                  |  |                             | 6.7   |                           | 
|Income tax provision                        |  |                             | 2.8   |                           | 
|                                            |  |                             |       |                           | 
|Net income                                  |  |                             | 3.9   | %                         | 
|                                            |  |                             |       |                           | 
|As a percentage of related revenues:        |  |                             |       |                           | 
|Cost of licenses                            |  |                             | 2.6   | %                         | 
|Cost of services                            |  |                             | 20.1  | %                         | 

Three Months Ended June 30, 2002 and 2003

Revenues

Total revenues increased 14.5% to $70.8 million for the three months ended June 30, 2003 from
$61.9 million in the comparable period of 2002.

License RevenuesLicense revenues increased 5.6% to $41.2 million for the
three months ended June 30, 2003 from $39.0 million in the comparable period of 2002. License revenues represented 58.1% of total revenues for the three months ended June 30, 2003, compared to 63.0% for the same period of 2002. License revenues
outside of North America accounted for 33.1% and 30.6% of total license revenues for the three months ended June 30, 2002 and 2003, respectively.

License revenue growth from the prior year primarily derived from the acquisition of Sitraka, Inc. in November 2002 as well as the devaluation of the U.S.
Dollar relative to certain foreign currencies, primarily the Euro and the British Pound. License revenues in the quarter reflected year-over-year declines in sales of our high availability products for Oracle and our Vista output management
products. Other product areas were generally flat year over year, with growth being seen in our Application Performance Management products such as Foglight and our Microsoft Infrastructure products. License revenues as a percentage of total
revenues have declined because revenues from software maintenance have had higher growth rates than revenues from licenses.

Service
RevenuesService revenues increased by 29.6% to $29.7 million for the three months ended June 30, 2003 from $22.9 million for the same period in 2002. Service revenues outside of North America accounted for 16.9% and 24.2% of total service
revenues for the three months ended June 30, 2002 and 2003, respectively. Higher maintenance revenues derived from the contribution of Sitrakas product maintenance revenues, higher maintenance revenues generated by a larger customer base and
the devaluation of the U.S. Dollar relative to certain foreign currencies, primarily the Euro and the British Pound. Revenues from professional services represented 8.8% and 11.8% of total service revenues for the three months ended June 30, 2002
and 2003, respectively.

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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 2.6% and 2.8% for the three months ended June 30, 2002 and
2003, respectively. We expect that cost of licenses as a percentage of license revenues will remain relatively constant throughout 2003.

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 $0.8 million to $5.3 million for the three months ended June 30, 2003 from $4.6 million in the same period of 2002, representing an increase of 16.3%. 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
83.3% to $2.4 million for the three months ended June 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 Sitraka in 2002 and eCritical
and Discus in the second quarter of 2003, offset slightly by purchased intangible assets from acquisitions made in 2000 that were fully amortized by the end of 2002. See Note 4 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 13.7% to $35.9 million for the three months ended June 30, 2003 from $31.6 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 expenses from higher license revenues and commission rate increases and to the U.S. Dollar devaluation.
Employee severance costs contributed approximately $0.4 million to sales and marketing expenses in the June 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 12.5% to $17.0 million for the three months ended June 30, 2003 from $15.1 million in the comparable period of 2002. Additional
headcount from our acquisition of Sitraka was the main reason for the increase in research and development expenses. Also contributing to the increase in research and development was the US Dollar devaluation and severance costs of approximately
$0.2 million.

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 $7.3 million for the three months ended June
30, 2003 from $6.3 million in the same period of 2002, representing an increase of $1.0 million or 15.3%. The increase is primarily attributable to the inclusion of Sitrakas general and administrative expenses, the US Dollar devaluation and an
increase in directors and officers liability insurance premiums.

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 Sitraka, eCritical and Discus, these costs increased to $0.9 million for the three
months ended June 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 $4.0 million for the three months ended June 30, 2003 and $3.7 million for the
same period of 2002 with the increase being attributable to foreign currency gains on certain non-U.S. Dollar denominated assets, primarily accounts receivable in English Pounds and Euros. Foreign currency gains were $2.8 million and $1.7 million in
the three months ended June 30, 2003 and 2002, respectively. Interest income for the three months ended June 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.

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. Write-down of investments was $1.1 million for the three months ended June 30, 2002.

Income TaxesProvision for income taxes was $1.7 million and $1.8 million for the three months ended June 30, 2002 and 2003, respectively, representing
effective rates for these periods of 41.7% and 37.4%. The decline in the effective tax rate is primarily the result of increased research and development tax credits as a percentage of income before income tax provision.

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Six Months Ended June 30, 2002 and 2003

Revenues

Total revenues increased 16.9% to $142.0 million for the six months ended June 30, 2003 from $121.5 million in the comparable period of 2002.

License RevenuesLicense revenues increased 9.5% to $83.9 million for the six months ended June 30, 2003 from $76.6 million in the comparable
period of 2002. License revenues represented 59.1% of total revenues for the six months ended June 30, 2003, compared to 63.1% for the same period of 2002. License revenues outside of North America accounted for 29.2% and 27.6% of total license
revenues for the six months ended June 30, 2002 and 2003, respectively.License revenue growth from the prior year primarily derived from the acquisition of Sitraka, Inc. in November 2002 as well as the devaluation of the U.S. Dollar
relative to certain other foreign currencies, primarily the Euro and the British Pound, offset by declining sales of our high availability products for Oracle and our Vista output management products.

Service RevenuesService revenues increased by 29.7% to $58.1 million for the six months ended June 30, 2003 from $44.8 million for the same period in
2002. Service revenues outside of North America accounted for 16.8% and 23.6% of total service revenues for the six months ended June 30, 2002 and 2003, respectively. Higher renewal maintenance fees derived from a larger customer base of installed
products, the contribution of Sitrakas support revenues and the devaluation of the US Dollar to certain other foreign currencies, primarily the Euro and the British Pound. Revenues from professional services represented 10.2% and 10.4% of
total service revenues for the six months ended June 30, 2002 and 2003, respectively.

Cost of Revenues

Cost of LicensesCost of licenses as a percentage of license revenues was 2.5% for the six months ended June 30, 2002 and 2003.

Cost of ServicesCost of services increased by $1.6 million to $10.5 million for the six months ended June 30, 2003 from $9.0 million in the same
period of 2002, representing an increase of 17.6%. Cost of services as a percentage of service revenues declined to 18.1% for the six months ended June 30, 2003, compared to 20.0% 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 67.0% to $4.5 million for the six months ended June 30, 2003 from $2.7 million in the same period of 2002. The increase is primarily due to amortization of purchased intangible assets related to the acquisitions of Sitraka in 2002
and eCritical and Discus in the second quarter of 2003, offset slightly by purchased intangible assets from acquisitions made in 2000 that were fully amortized by the end of 2002. See Note 4 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 increased 16.9% to $72.0 million for the six months ended June 30, 2003 from $61.6 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 expenses from higher license revenues and commission rate increases and the US Dollar devaluation.

Research and DevelopmentResearch and development expenses increased 12.9% to $34.2 million for the six months ended June 30, 2003 from $30.3 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. U.S. Dollar devaluation also contributed to the increase in research and development
expenses in the six months ended June 30, 2003.

General and AdministrativeGeneral and administrative expenses increased to
$13.8 million for the six months ended June 30, 2003 from $12.2 million in

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the same period of 2002, representing an increase of $1.6 million or 13.4%. The increase is primarily attributable to the inclusion of Sitrakas general and administrative
expenses, the U.S. Dollar devaluation, as well as increases for rent, legal expenses and directors and officers liability insurance premiums offset slightly by a reduction of bad debt expense.

Intangible Asset AmortizationAs a result of the acquisition of Sitraka, eCritical and Discus, these costs increased to $1.8 million for the six months
ended June 30, 2003 from $0.9 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 $5.8 million for the six months ended June 30, 2003 and $5.5 million for the same period of 2002, with the increase being attributable to foreign currency gains on certain non-U.S. dollar denominated
assets, primarily accounts receivable in English Pounds and Euros. Foreign currency gains were $3.5 million and $1.7 million in the six months ended June 30, 2003 and 2002, respectively. The interest income component of other income (expense) for
the six months ended June 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 was $1.1 million for the
six months ended June 30, 2002.

Income TaxesProvision for income taxes was $3.1 million and $3.4 million for the six
months ended June 30, 2002 and 2003, respectively, representing effective rates for these periods of 41.5% and 37.5%. The decline in the effective tax rate is primarily the result of increased research and development tax credits as a percentage of
income before income tax provision.

Liquidity and Capital Resources

As of June 30,
2003, cash equivalents and short-term marketable securities were $138.0 million and we held $97.6 million of long-term investment grade corporate and government securities.  As of June 30, 2003, we had $2.0 million of debt assumed in an
acquisition in September 2000 and $38.6 million of long-term contractual obligations associated with facilities leases, as described below.

Net cash provided by operating activities was $32.0 million and $24.6 million for the six months ended June 30, 2003 and 2002, respectively. The increase in cash from
operating activities in the six months ended June 30, 2003 was driven primarily by strong cash collections on first quarter 2003 transactions as well as higher net income, depreciation expense, income taxes payable and deferred revenue.

Investing activities provided $0.2 million during the six months ended June 30, 2003, consisting of $8.7 million net cash from sales of marketable
securities offset by $3.8 million in capital expenditures and $4.7 million paid for acquisitions, net of cash acquired. Net cash used in investing activities was $28.6 million in the six months ended June 30, 2002, consisting of $22.2 million net
cash paid for purchases of marketable securities, $2.3 million in capital expenditures and $4.1 million paid for an acquisition. Capital expenditures primarily consisted of information technology hardware and software purchases.

Financing activities generated $3.3 million and $6.2 million in the six months ended June 30, 2002 and 2003, 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 Quest may purchase up to two million shares of its 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 June 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 stock option and stock purchase plans. No shares of common stock were repurchased under this
plan during the six months ended June 30, 2002 or 2003.

As of June 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 $14.7 million in 2003, $10.9 million in 2004, $8.3 million in 2005, $4.2 million in 2006 and $2.4 million thereafter. In connection with our acquisition of Discus Data, we agreed 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. 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.

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.

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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.

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

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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 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 June 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 and 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 12. 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 3 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

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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, 2003.  We do not expect that the adoption of
this standard will have a material effect on our 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 do not expect that the adoption of this standard will have a material effect on our 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.

Risks
Related to Our Business

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

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

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

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 recent 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.

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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.                                                                                         

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 3 of 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.

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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.

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 our
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.

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

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

Natural disasters or power outages could disrupt our business

A substantial portion of our operations are located in California, and we are subject to risks of damage and business disruptions resulting from earthquakes, floods
and similar events, as well as from power outages. We have 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.

Risks Related to Our Industry

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

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

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potential to produce either gains or losses. Our cumulative currency gains or losses in any given period are typically lessened by the economic benefits of diversification and
low correlation between different currencies, but there can be no assurance that this pattern will continue to be true in future periods.

The foreign currencies to which we currently have the most significant exposure are the Canadian dollar, the British pound, the Euro and the Australian dollar. Based
on our overall currency rate exposure at June 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):

|                                 |  | Amortized Book Value |         | Weighted Average Rate | 
|-------------------------------- |  | -------------------- | ------- | --------------------- | 
|                                 |  |                      |         |                       | 
|Investments maturing by June 30, |  |                      |         |                       | 
|2004                             |  | $                    | 140,003 |                       | 
|2005                             |  |                      | 12,783  |                       | 
|2006                             |  |                      | 24,101  |                       | 
|2007                             |  |                      | 30,000  |                       | 
|Thereafter                       |  |                      | 26,824  |                       | 
|                                 |  |                      |         |                       | 
|Total portfolio                  |  | $                    | 233,711 |                       | 
|                                 |  |                      |         |                       | 

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 June 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:

We have corrected the process by which we apply historic currency exchange rates to transactions affecting
property and equipment and deferred revenue balances of foreign subsidiaries in order to ensure that we correctly translate foreign currencies and report gains and losses on foreign exchange rate fluctuations in accordance with Statement of
Financial Accounting Standard No. 52. 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. 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.  As of the time of filing of this report, these complaints have not yet been consolidated and neither a lead plaintiff nor lead counsel has been appointed. 
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 4:Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Shareholders was held on May 29, 2003. There was no solicitation in opposition to the managements nominees as listed in Quests proxy
statement, and all of such nominees were elected. At the Annual Meeting, our shareholders also ratified the appointment of Deloitte & Touche LLP as Quests independent auditors for the fiscal year ending December 31, 2003 and approved an
increase in the number of shares available for issuance under our1999 Stock Incentive Plan and 1999 Employee Stock Purchase Plan. Set forth below are the number of votes cast for, against or abstaining, as to each matter (there were no broker
non-votes).

1.  Election of Directors:

|Nominee               |  | For        |  | Against |  | Abstain | 
|--------------------- |  | ---------- |  | ------- |  | ------- | 
|                      |  |            |  |         |  |         | 
|Vincent C. Smith      |  | 83,919,599 |  | 0       |  | 540,334 | 
|David M. Doyle        |  | 83,919,599 |  | 0       |  | 540,334 | 
|Doran G. Machin       |  | 83,909,185 |  | 0       |  | 550,748 | 
|Jerry Murdock, Jr.    |  | 83,919,599 |  | 0       |  | 540,334 | 
|Raymond J. Lane       |  | 83,919,599 |  | 0       |  | 540,334 | 
|Augustine L. Nieto II |  | 83,919,599 |  | 0       |  | 540,334 | 

2.  Increase in number of shares
reserved for issuance under our 1999 Stock Incentive Plan:

|For        |  | Against    |  | Abstain | 
|---------- |  | ---------- |  | ------- | 
|           |  |            |  |         | 
|48,833,251 |  | 26,907,089 |  | 3,330   | 

3.  Increase in number of shares
available for issuance under our 1999 Employee Stock Purchase Plan:

|For        |  | Against   |  | Abstain | 
|---------- |  | --------- |  | ------- | 
|           |  |           |  |         | 
|73,904,943 |  | 1,835,572 |  | 3,155   | 

4.  Ratification of Appointment of
Deloitte & Touche LLP:

|For        |  | Against   |  | Abstain | 
|---------- |  | --------- |  | ------- | 
|           |  |           |  |         | 
|82,845,348 |  | 1,609,904 |  | 4,681   | 

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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 April 23, 2003, we filed a Current Report on Form 8-K furnishing the press
release announcing our operating results for the quarter ended March 31, 2003.

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##### Table of Contents

SIGNATURES

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

|                | QUEST SOFTWARE, INC.                                                                 
|--------------- | -------------------------------------------------------------------------------------
|                |                                                                                      
|August 14, 2003 | /s/    M. BRINKLEY MORSE                                                             
|                |                                                                                      
|                | M. Brinkley Morse Vice President, Finance and Operations and  Chief Financial Officer
|                |                                                                                      
|                | /s/    KEVIN  E. BROOKS                                                              
|                |                                                                                      
|                | Kevin E. Brooks Principal Accounting Officer                                         

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