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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 March 31, 2005



OR



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



For the transition period from
 to



COMMISSION FILE NO. 000-26937



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QUEST SOFTWARE, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|California                                                     |  | 33-0231678                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                            |  |           
|------------------------------------------- |  | ----------
|8001 Irvine Center Drive Irvine, California |  | 92618     
|(Address of principal executive offices)    |  | (Zip code)



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



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



Yes  x    No ̈



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



Yes  x    No ̈



The number of shares outstanding of the Registrants Common Stock, no
par value, as of April 27, 2005, was 96,676,724.



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##### Table of Contents

QUEST SOFTWARE, INC.



FORM 10-Q



TABLE OF CONTENTS



|                              |  |                                                                                                                  |  |           
|----------------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----------
|                              |  |                                                                                                                  |  | PageNumber
|PART I. FINANCIAL INFORMATION |  |                                                                                                                 
|                              |  |                                                                                                                 
|Item 1.                       |  | Financial Statements (unaudited)                                                                                 |  |           
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004                                 |  | 2         
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004               |  | 3         
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004               |  | 4         
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Statements of Comprehensive Operations for the Three Months Ended March 31, 2005 and 2004 |  | 5         
|                              |  |                                                                                                                 
|                              |  | Notes to Condensed Consolidated Financial Statements                                                             |  | 6         
|                              |  |                                                                                                                 
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 13        
|                              |  |                                                                                                                 
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 32        
|                              |  |                                                                                                                 
|Item 4.                       |  | Controls and Procedures                                                                                          |  | 33        
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                 
|                              |  |                                                                                                                 
|Item 1.                       |  | Legal Proceedings                                                                                                |  | 34        
|                              |  |                                                                                                                 
|Item 6.                       |  | Exhibits                                                                                                         |  | 34        
|                              | 
|SIGNATURES                    |  | 35                                                                                                              





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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)



|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                             |  | March 31, 2005 |         |   | December 31, 2004 |  
|ASSETS                                                                                                                                                       |  |                |         |   |                   |   |         |  
|Current assets:                                                                                                                                              |  |                |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                    |  | $              | 121,544 |   |                   | $ | 118,157 |  
|Short-term marketable securities                                                                                                                             |  |                | 30,645  |   |                   |   | 15,892  |  
|Accounts receivable, net                                                                                                                                     |  |                | 54,456  |   |                   |   | 98,800  |  
|Prepaid expenses and other current assets                                                                                                                    |  |                | 11,978  |   |                   |   | 12,528  |  
|Deferred income taxes                                                                                                                                        |  |                | 13,107  |   |                   |   | 13,075  |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Total current assets                                                                                                                                         |  |                | 231,730 |   |                   |   | 258,452 |  
|                                                                                                                                                             |  |               
|Property and equipment, net                                                                                                                                  |  |                | 53,321  |   |                   |   | 52,761  |  
|Long-term marketable securities                                                                                                                              |  |                | 145,511 |   |                   |   | 163,527 |  
|Amortizing intangible assets, net                                                                                                                            |  |                | 41,964  |   |                   |   | 41,404  |  
|Goodwill                                                                                                                                                     |  |                | 332,339 |   |                   |   | 323,903 |  
|Other assets                                                                                                                                                 |  |                | 3,192   |   |                   |   | 3,304   |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Total assets                                                                                                                                                 |  | $              | 808,057 |   |                   | $ | 843,351 |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                         |  |                |         |   |                   |   |         |  
|Current liabilities:                                                                                                                                         |  |                |         |   |                   |   |         |  
|Accounts payable                                                                                                                                             |  | $              | 4,819   |   |                   | $ | 4,135   |  
|Obligation under repurchase agreement                                                                                                                        |  |                |        |   |                   |   | 12,632  |  
|Accrued compensation                                                                                                                                         |  |                | 21,037  |   |                   |   | 27,802  |  
|Other accrued expenses                                                                                                                                       |  |                | 22,667  |   |                   |   | 46,292  |  
|Income taxes payable                                                                                                                                         |  |                | 9,642   |   |                   |   | 12,030  |  
|Current portion of deferred revenue                                                                                                                          |  |                | 106,618 |   |                   |   | 106,356 |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                    |  |                | 164,783 |   |                   |   | 209,247 |  
|                                                                                                                                                             |  |               
|Long-term liabilities:                                                                                                                                       |  |                |         |   |                   |   |         |  
|Long-term portion of deferred revenue                                                                                                                        |  |                | 19,975  |   |                   |   | 20,897  |  
|Deferred income taxes                                                                                                                                        |  |                | 4,520   |   |                   |   | 4,526   |  
|Other long-term liabilities                                                                                                                                  |  |                | 1,609   |   |                   |   | 1,769   |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Total long-term liabilities                                                                                                                                  |  |                | 26,104  |   |                   |   | 27,192  |  
|                                                                                                                                                             |  |               
|Commitments and contingencies (Note 3 and 10)                                                                                                                |  |                |         |   |                   |   |         |  
|                                                                                                                                                             |  |               
|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; 96,295 and 96,111 shares issued and outstanding at March 31, 2005 and December 31,
2004, respectively |  |                | 629,500 |   |                   |   | 628,149 |  
|Retained earnings                                                                                                                                            |  |                | 9,173   |   |                   |   | 147     |  
|Accumulated other comprehensive loss                                                                                                                         |  |                | (1,972  | ) |                   |   | (776    | )
|Unearned compensation                                                                                                                                        |  |                | (2,317  | ) |                   |   | (3,394  | )
|Note receivable from sale of common stock                                                                                                                    |  |                | (17,214 | ) |                   |   | (17,214 | )
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Net shareholders equity                                                                                                                                     |  |                | 617,170 |   |                   |   | 606,912 |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  
|Total liabilities and shareholders equity                                                                                                                   |  | $              | 808,057 |   |                   | $ | 843,351 |  
|                                                                                                                                                             |  |                |         |   |                   |   |         |  



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 EndedMarch 31,
|                                                  |  | 2005                        |         |   | 2004
|Revenues:                                         |  |                             |         |   |      |   |       
|Licenses                                          |  | $                           | 54,718  |   |      | $ | 47,028
|Services                                          |  |                             | 48,630  |   |      |   | 35,499
|                                                  |  |                             |         |   |      |   |       
|Total revenues                                    |  |                             | 103,348 |   |      |   | 82,527
|                                                  |  |                            
|Cost of revenues:                                 |  |                             |         |   |      |   |       
|Licenses                                          |  |                             | 968     |   |      |   | 1,097 
|Services                                          |  |                             | 8,675   |   |      |   | 6,403 
|Amortization of purchased technology              |  |                             | 2,255   |   |      |   | 1,431 
|                                                  |  |                             |         |   |      |   |       
|Total cost of revenues                            |  |                             | 11,898  |   |      |   | 8,931 
|                                                  |  |                             |         |   |      |   |       
|Gross profit                                      |  |                             | 91,450  |   |      |   | 73,596
|                                                  |  |                            
|Operating expenses:                               |  |                             |         |   |      |   |       
|Sales and marketing                               |  |                             | 43,393  |   |      |   | 36,124
|Research and development                          |  |                             | 21,120  |   |      |   | 18,158
|General and administrative                        |  |                             | 9,702   |   |      |   | 8,260 
|Amortization of other purchased intangible assets |  |                             | 1,276   |   |      |   | 730   
|In-process research and development               |  |                             | 1,050   |   |      |   | 6,700 
|                                                  |  |                             |         |   |      |   |       
|Total operating expenses                          |  |                             | 76,541  |   |      |   | 69,972
|                                                  |  |                             |         |   |      |   |       
|Income from operations                            |  |                             | 14,909  |   |      |   | 3,624 
|Other (expense) income, net                       |  |                             | (1,510  | ) |      |   | 667   
|                                                  |  |                             |         |   |      |   |       
|Income before income tax provision                |  |                             | 13,399  |   |      |   | 4,291 
|Income tax provision                              |  |                             | 4,360   |   |      |   | 3,905 
|                                                  |  |                             |         |   |      |   |       
|Net income                                        |  | $                           | 9,039   |   |      | $ | 386   
|                                                  |  |                             |         |   |      |   |       
|Net income per share:                             |  |                             |         |   |      |   |       
|Basic                                             |  | $                           | 0.09    |   |      | $ | 0.00  
|                                                  |  |                             |         |   |      |   |       
|Diluted                                           |  | $                           | 0.09    |   |      | $ | 0.00  
|                                                  |  |                             |         |   |      |   |       
|Weighted average shares:                          |  |                             |         |   |      |   |       
|Basic                                             |  |                             | 96,195  |   |      |   | 93,802
|Diluted                                           |  |                             | 99,585  |   |      |   | 97,970



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)



|                                                                                  |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Three Months EndedMarch 31, |        
|                                                                                  |  | 2005                        |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                             |         |   |      |   |         |  
|Net income                                                                        |  | $                           | 9,039   |   |      | $ | 386     |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                             |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |                             | 6,148   |   |      |   | 5,402   |  
|Compensation expense associated with stock option grants                          |  |                             | 683     |   |      |   | 170     |  
|Deferred income taxes                                                             |  |                             | (41     | ) |      |   | 3       |  
|Tax benefit related to stock option exercises                                     |  |                             | 259     |   |      |   | 1,540   |  
|Provision for bad debts                                                           |  |                             | (80     | ) |      |   | (23     | )
|In-process research and development                                               |  |                             | 1,050   |   |      |   | 6,700   |  
|                                                                                  |  |                            
|Changes in operating assets and liabilities, net of effects of acquisitions:      |  |                             |         |   |      |   |         |  
|Accounts receivable                                                               |  |                             | 43,513  |   |      |   | 9,807   |  
|Prepaid expenses and other current assets                                         |  |                             | 461     |   |      |   | (2,331  | )
|Other assets                                                                      |  |                             | 141     |   |      |   | (3      | )
|Accounts payable                                                                  |  |                             | 548     |   |      |   | 493     |  
|Accrued compensation                                                              |  |                             | (6,614  | ) |      |   | (1,116  | )
|Other accrued expenses                                                            |  |                             | (8,035  | ) |      |   | (4,796  | )
|Litigation settlement payment                                                     |  |                             | (16,000 | ) |      |   |        |  
|Income taxes payable                                                              |  |                             | (2,351  | ) |      |   | 1,262   |  
|Deferred revenue                                                                  |  |                             | (1,010  | ) |      |   | 4,843   |  
|Other liabilities                                                                 |  |                             | (108    | ) |      |   | 415     |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                             | 27,603  |   |      |   | 22,752  |  
|                                                                                  |  |                            
|Cash flows from investing activities:                                             |  |                             |         |   |      |   |         |  
|Purchases of property and equipment, net                                          |  |                             | (3,039  | ) |      |   | (16,586 | )
|Cash paid for acquisitions, net of cash acquired                                  |  |                             | (12,754 | ) |      |   | (94,283 | )
|Proceeds from investments in marketable securities                                |  |                             | 2,064   |   |      |   | 13,005  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash used in investing activities                                             |  |                             | (13,729 | ) |      |   | (97,864 | )
|                                                                                  |  |                            
|Cash flows from financing activities:                                             |  |                             |         |   |      |   |         |  
|Proceeds from repurchase agreement                                                |  |                             |        |   |      |   | 67,500  |  
|Repayment of repurchase agreement                                                 |  |                             | (12,725 | ) |      |   |        |  
|Repayment of capital lease obligations                                            |  |                             | (85     | ) |      |   | (92     | )
|Proceeds from the exercise of stock options                                       |  |                             | 1,472   |   |      |   | 4,288   |  
|Proceeds from employee stock purchase plan                                        |  |                             |        |   |      |   | 2,723   |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Net cash (used in) provided by financing activities                               |  |                             | (11,338 | ) |      |   | 74,419  |  
|Effect of exchange rate changes on cash and cash equivalents                      |  |                             | 851     |   |      |   | (821    | )
|                                                                                  |  |                             |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                             | 3,387   |   |      |   | (1,514  | )
|Cash and cash equivalents, beginning of period                                    |  |                             | 118,157 |   |      |   | 67,470  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                          |  | $                           | 121,544 |   |      | $ | 65,956  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Supplemental schedule of non-cash investing and financing activities:             |  |                             |         |   |      |   |         |  
|Unrealized (loss) gain on available-for-sale securities                           |  | $                           | (1,196  | ) |      | $ | 905     |  
|                                                                                  |  |                             |         |   |      |   |         |  



See Note 3 for details of assets
acquired and liabilities assumed in purchase transactions.



See
accompanying notes to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS

(In thousands)

(Unaudited)



|                                                                    |  |                             |        |   |      |   |      
|------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | -----
|                                                                    |  | Three Months EndedMarch 31,
|                                                                    |  | 2005                        |        |   | 2004
|Net income                                                          |  | $                           | 9,039  |   |      | $ | 386  
|                                                                    |  |                            
|Other comprehensive (loss) income:                                  |  |                             |        |   |      |   |      
|Unrealized (loss) gain on available-for-sale securities, net of tax |  |                             | (1,196 | ) |      |   | 905  
|                                                                    |  |                             |        |   |      |   |      
|Comprehensive income                                                |  | $                           | 7,843  |   |      | $ | 1,291
|                                                                    |  |                             |        |   |      |   |      



See accompanying notes
to condensed consolidated financial statements.



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QUEST SOFTWARE, INC.



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



1. Basis of
Presentation



Our accompanying unaudited condensed
consolidated financial statements as of March 31, 2005 and for the three months ended March 31, 2004 and 2005, 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 financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. The results for the interim periods presented are not necessarily indicative of the results that may
be expected for any future period.



Recently Issued Accounting
Pronouncements



In December 2004, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123R), that upon implementation, will impact our net
income and net income per share and change the classification of certain elements in the statement of cash flows. SFAS 123R eliminates the alternative to use the intrinsic value method of accounting under SFAS No. 123 and supersedes Accounting
Principles Board (APB) Opinion No. 25, and its related implementation guidance. Under APB Opinion 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. SFAS 123R will require us to measure all employee stock-based compensation awards using a fair value method and record such amounts as an expense in our statement of operations, on a prospective basis, as the
underlying options vest. In April 2005, the Securities and Exchange Commission amended the compliance dates for SFAS 123R to require adoption at the beginning of fiscal years beginning after June 15, 2005. We are required to adopt SFAS 123R in our
first quarter of 2006, with expensing to begin January 1, 2006. See Stock Based Compensation in Note 2 of these Notes to Condensed Consolidated Financial Statements for the pro forma net income and net income
per share amounts, for the three months ended March 31, 2005 and 2004, as if we had used one of the fair-value-based methods, similar to the methods available under SFAS 123R, to measure compensation expense for employee stock incentive awards.
While we are still evaluating the requirements under and effects of SFAS 123R we expect the adoption to have a significant adverse impact on our consolidated income from operations, net income and net income per share.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-1
(FAS 109-1), Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (AJCA). The
AJCA introduces a special 9% tax deduction on qualified production activities, which is phased in through 2010. FAS 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with Statement 109. This
provision may provide a tax benefit to us from both a financial statement effective tax rate perspective and as a deduction on our tax return, which may effectively reduce the amount of taxes owed.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-2
(FAS 109-2), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004. The AJCA introduces a limited time 85% dividends received deduction on the
repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. We expect to complete our evaluation of
the effects of the repatriation provision by the end of the third quarter of 2005.



In March 2004, the FASB issued EITF Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments which provided new guidance for
assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however,
the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once final guidance is issued.



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2. Stock Based Compensation



We account for stock-based awards to employees using the intrinsic value method, as prescribed by Accounting Principles
Board (APB) Opinion No. 25Accounting for Stock Issued to Employees and interpretations thereof. Under APB Opinion No. 25, compensation expense is based on the difference, as of the date of the grant, between the fair
value of our stock and the exercise price. Generally, the exercise price of options granted under our stock option plans is equal to the market value of the underlying stock on the date of grant, thereby giving rise to no compensation expense. We
value stock options assumed in purchase business combinations at the date of acquisition at their fair value calculated using the Black-Scholes option-pricing model. The purchase price of these business combinations includes the fair value of
assumed vested options while the intrinsic value attributable to unvested options is recorded as unearned compensation and amortized over the remaining vesting period of the stock options. We 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.



Pro forma information regarding net income and earnings per share is required by SFAS No. 123Accounting for Stock Based Compensation.
This information is required to be determined as if we had accounted for our employee stock options and stock purchase plans under the fair value based method. Had compensation cost been determined using the fair value method our net income would
have been adjusted to the pro forma net income (loss) amounts indicated below (in thousands, except per share data):



|                                                                                                                           |  |                             |        |   |      |   |        |  
|-------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                           |  | Three Months EndedMarch 31, |       
|                                                                                                                           |  | 2005                        |        |   | 2004 |  
|Net income (loss):                                                                                                         |  |                             |        |   |      |   |        |  
|As reported                                                                                                                |  | $                           | 9,039  |   |      | $ | 386    |  
|Add: Stock-based compensation expense included in reported net income, net of related tax effects                          |  |                             | 438    |   |      |   | 109    |  
|Deduct: Total stock-based compensation determined under fair value based method for all awards, net of related tax effects |  |                             | (7,174 | ) |      |   | (6,854 | )
|                                                                                                                           |  |                             |        |   |      |   |        |  
|Pro forma                                                                                                                  |  | $                           | 2,303  |   |      | $ | (6,359 | )
|                                                                                                                           |  |                             |        |   |      |   |        |  
|Basic net income (loss) per share:                                                                                         |  |                             |        |   |      |   |        |  
|As reported                                                                                                                |  | $                           | 0.09   |   |      | $ | 0.00   |  
|Pro forma                                                                                                                  |  | $                           | 0.02   |   |      | $ | (0.07  | )
|                                                                                                                           |  |                            
|Diluted net income (loss) per share:                                                                                       |  |                             |        |   |      |   |        |  
|As reported                                                                                                                |  | $                           | 0.09   |   |      | $ | 0.00   |  
|Pro forma                                                                                                                  |  | $                           | 0.02   |   |      | $ | (0.07  | )



For purposes of
estimating the compensation cost of our option grants the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. We use projected
volatility rates, which are based upon historical volatility rates trended into future years. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in managements opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options. These fair value calculations for options granted in
the three months ended March 31, 2005 and 2004 are based on the following assumptions:



|                          |  |                             |   |  |      |  
|------------------------- |  | --------------------------- | - |  | ---- | -
|                          |  | Three Months EndedMarch 31, |  
|                          |  | 2005                        |   |  | 2004 |  
|Risk-free interest rate   |  | 4.20                        | % |  | 2.78 | %
|Expected life (in years)  |  | 6.50                        |   |  | 5.00 |  
|Expected stock volatility |  | 51                          | % |  | 45   | %
|Expected dividends        |  | None                        |   |  | None |  



7



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##### Table of Contents

3. Acquisitions



We acquired Wingra Technologies, LLC (Wingra), a provider of messaging integration and migration solutions, during the three months ended
March 31, 2005. The purchase price for the transaction, consisting primarily of cash, totaled $13.1 million, and was preliminarily allocated as follows: $8.0 million to goodwill, $3.4 million to purchased technology, $1.1 million to in-process
research and development, $0.6 million to other purchased intangibles, $1.0 million to total assets acquired and $(1.0) million to total liabilities assumed. Goodwill is expected to be deductible for tax purposes and was assigned to our business
segments as follows: $6.4 million to the licenses segment and $1.6 million to the services segment. The purchase price allocation is preliminary and subject to change based upon additional information related to the valuation of certain intangible
assets. Actual results of operations of Wingra are included in our condensed consolidated financial statements from January 18, 2005, the effective date of this acquisition. The pro forma impact of the Wingra acquisition was not significant to the
periods presented.



On March 17, 2004, we acquired Aelita
Software Corporation (Aelita), a leading provider of systems management solutions for Microsoft Active Directory and Microsoft Exchange products. The acquisition expands our product portfolio of solutions to simplify, automate and secure
increasingly complex Microsoft infrastructures. The purchase price for Aelita was $117.3 million, consisting of $102.0 million in cash, the assumption of Aelita stock options valued at $13.4 million using the Black-Scholes option pricing model and
direct acquisition costs of $1.9 million. The intrinsic value of unvested stock options of $4.0 million was allocated to unearned compensation and is being recognized as a non-cash compensation expense. Of the cash paid for this acquisition, $15.8
million was deposited in escrow to satisfy certain indemnification obligations of the selling shareholders. In-process research and development of $6.7 million was expensed immediately upon completion of the acquisition. Goodwill in the amount of
$67.4 million and $19.0 million was assigned to the license and service segments, respectively, of our business and is not expected to be deductible for tax purposes. Goodwill allocation of 78% to licenses and 22% to services is based on both
historical and projected relative contribution from licenses and services revenues.



In connection with our acquisition of Aelita, the merger agreement requires us to make certain payments to the former stockholders of Aelita in respect of assumed Aelita options that are prematurely forfeited within
eighteen months of the acquisition date. We estimate the maximum possible exposure to be approximately $2.8 million as of March 31, 2005, and any such payments will be considered additional purchase price. As of March 31, 2005, we have accrued an
obligation of $0.5 million representing the amount we estimate to become payable under this provision based on assumed Aelita options which have been prematurely forfeited through March 31, 2005, which amount is recorded on the balance sheet in
other accrued expenses.



Actual results of operations of Aelita
are included in our condensed consolidated financial statements from March 17, 2004, the effective date of this acquisition. The unaudited financial information in the table below summarizes the combined results of operations of Quest and Aelita, on
a pro forma basis, as though the companies had been combined as of the beginning of the period presented, and combines the historical results for Quest for the three months ended March 31, 2004 and Aelitas historical results for the period
from January 1, 2004 to March 17, 2004. The pro forma financial information includes amortization of identified intangibles and unearned compensation charges of $1.6 million and $0.4 million, respectively, that we would have recognized had the
Aelita acquisition closed on January 1, 2004. 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
acquisition taken place at the beginning of the period presented (in thousands, except per share data):



|                    |  |                                  |        |  
|------------------- |  | -------------------------------- | ------ | -
|                    |  | Three Months EndedMarch 31, 2004 |       
|Revenues            |  | $                                | 89,073 |  
|Net loss            |  | $                                | (3,823 | )
|                    | 
|Net loss per share: |  |                                  |        |  
|Basic               |  | $                                | (0.04  | )
|Diluted             |  | $                                | (0.04  | )



4. Goodwill and Amortizing
Intangible Assets



Amortizing intangible assets are
comprised of the following (in thousands):



|                               |  |                     |        |                                   |   |                   |     |                                   |   |                     |  |                         |  |   |        |  |   |         |   |  |   |        |  |    
|------------------------------ |  | ------------------- | ------ | --------------------------------- | - | ----------------- | --- | --------------------------------- | - | ------------------- |  | ----------------------- |  | - | ------ |  | - | ------- | - |  | - | ------ |  | ---
|                               |  | March 31, 2005      |        | WeightedAverageAmortizationPeriod |   | December 31, 2004 |     | WeightedAverageAmortizationPeriod
|                               |  | GrossCarryingAmount |        | AccumulatedAmortization           |   |                   | Net |                                   |   | GrossCarryingAmount |  | AccumulatedAmortization |  |   | Net    | 
|Acquired technology            |  | $                   | 69,259 |                                   | $ | (37,344           | )   |                                   | $ | 31,915              |  | 5.3                     |  | $ | 65,809 |  | $ | (35,089 | ) |  | $ | 30,720 |  | 5.4
|Customer lists                 |  |                     | 12,551 |                                   |   | (8,199            | )   |                                   |   | 4,352               |  | 2.7                     |  |   | 11,911 |  |   | (7,424  | ) |  |   | 4,487  |  | 2.6
|Existing maintenance contracts |  |                     | 3,000  |                                   |   | (637              | )   |                                   |   | 2,363               |  | 4.9                     |  |   | 3,000  |  |   | (482    | ) |  |   | 2,518  |  | 4.9
|Non-compete agreement          |  |                     | 5,325  |                                   |   | (3,030            | )   |                                   |   | 2,295               |  | 3.2                     |  |   | 5,325  |  |   | (2,832  | ) |  |   | 2,493  |  | 3.2
|Trademarks                     |  |                     | 2,050  |                                   |   | (1,011            | )   |                                   |   | 1,039               |  | 4.1                     |  |   | 2,050  |  |   | (864    | ) |  |   | 1,186  |  | 4.1
|                               |  |                     |        |                                   |   |                   |     |                                   |   |                     |  |                         |  |   |        |  |   |         |   |  |   |        |  |    
|                               |  | $                   | 92,185 |                                   | $ | (50,221           | )   |                                   | $ | 41,964              |  |                         |  | $ | 88,095 |  | $ | (46,691 | ) |  | $ | 41,404 |  |    
|                               |  |                     |        |                                   |   |                   |     |                                   |   |                     |  |                         |  |   |        |  |   |         |   |  |   |        |  |    



8



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##### Table of Contents

Amortization expense for amortizing intangible assets was $3.5 million and $2.2 million for the three
months ended March 31, 2005 and 2004, respectively. Estimated annual amortization expense related to amortizing intangible assets by fiscal year is as follows:



|                            |  |                                      |       
|--------------------------- |  | ------------------------------------ | ------
|                            |  | Estimated AnnualAmortization Expense
|2005 (remaining 3 quarters) |  | $                                    | 10,393
|2006                        |  |                                      | 11,331
|2007                        |  |                                      | 9,806 
|2008                        |  |                                      | 7,799 
|2009 and thereafter         |  |                                      | 2,635 
|                            |  |                                      |       
|                            |  | $                                    | 41,964
|                            |  |                                      |       



All intangible assets
currently recorded will be fully amortized by the end of 2010.



The changes in the carrying amount of goodwill by reportable operating segment for the three months ended March 31, 2005 are as follows (in thousands):



|                                     |  |          |         |          |   |        |  |   |        
|------------------------------------ |  | -------- | ------- | -------- | - | ------ |  | - | -------
|                                     |  | Licenses |         | Services |   | Total 
|Balance as of December 31, 2004      |  | $        | 248,236 |          | $ | 75,667 |  | $ | 323,903
|Adjustments to Aelita purchase price |  |          | 405     |          |   | 114    |  |   | 519    
|Wingra acquisition and other         |  |          | 6,334   |          |   | 1,583  |  |   | 7,917  
|                                     |  |          |         |          |   |        |  |   |        
|Balance as of March 31, 2005         |  | $        | 254,975 |          | $ | 77,364 |  | $ | 332,339
|                                     |  |          |         |          |   |        |  |   |        



5. Obligation Under Repurchase
Agreement



We entered into a repurchase agreement in March
2004, utilizing $67.6 million of our investment securities as collateral. The cash proceeds of this transaction were used to provide funding for our acquisition of Aelita and our purchase of a new office facility. Our remaining obligation under this
agreement of $12.7 million was paid in full in February 2005.



6. Income Tax
Provision



The effective income tax rate for the three
months ended March 31, 2005 was 33% compared to 91% in the comparable period of 2004. The significant tax rate in the first quarter of 2004 was primarily due to a permanent difference between GAAP pre-tax income and taxable income as a result of a
$6.7 million non-deductible write-off of Aelitas in-process research and development in the three months ended March 31, 2004.



7. Other (Expense) Income, Net



Other (expense) income, net consists of the following (in thousands):



|                               |  |                             |        |   |      |   |       |  
|------------------------------ |  | --------------------------- | ------ | - | ---- | - | ----- | -
|                               |  | Three Months EndedMarch 31, |       
|                               |  | 2005                        |        |   | 2004 |  
|Interest income                |  | $                           | 1,904  |   |      | $ | 1,922 |  
|Interest expense               |  |                             | (61    | ) |      |   | (57   | )
|Foreign currency loss, net (a) |  |                             | (2,949 | ) |      |   | (969  | )
|Other expense, net             |  |                             | (404   | ) |      |   | (229  | )
|                               |  |                             |        |   |      |   |       |  
|Total                          |  | $                           | (1,510 | ) |      | $ | 667   |  
|                               |  |                             |        |   |      |   |       |  



|(a) | Foreign currency losses were predominantly attributable to translation losses on accounts receivable and cash denominated in primarily the Euro, and to a lesser extent, the British
Pound and the Australian Dollar. The foreign currency translation adjustments to these balance sheet items are calculated by comparing the currency spot rates on March 31, 2005 to the spot rates on December 31, 2004. On this basis the U.S. Dollar
strengthened against the Euro, the British Pound and the Australian Dollar during the periods presented.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



9



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##### Table of Contents

8. Net Income Per Share



Basic earnings per share is computed by dividing net income available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other common stock equivalents, including stock options, in the weighted-average number of common shares outstanding for a period, if
dilutive.



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



|                                                      |  |                             |  |       
|----------------------------------------------------- |  | --------------------------- |  | ------
|                                                      |  | Three Months EndedMarch 31,
|                                                      |  | 2005                        |  | 2004  
|Shares used in computing basic net income per share   |  | 96,195                      |  | 93,802
|Dilutive effect of stock options (a)                  |  | 3,390                       |  | 4,168 
|                                                      |  |                             |  |       
|Shares used in computing diluted net income per share |  | 99,585                      |  | 97,970
|                                                      |  |                             |  |       



|(a) | Options to purchase 8.2 million and 3.2 million shares of common stock were outstanding during the three months ended March 31, 2005 and 2004, respectively, but were not included in
the computation of net income per share as inclusion would have been anti-dilutive.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



9. Geographic and Segment Information



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



Our reportable operating segments are Licenses and Services. The Licenses
segment develops and markets licenses to use our software products. The Services segment provides after-sale support for software products and fee-based training and consulting services related to our software products.



We do not separately allocate operating expenses to these segments, nor do we
allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of revenues, and gross profit.



Reportable segment data is as follows (in thousands):



|                                  |  |          |        |          |   |        |  |   |        
|--------------------------------- |  | -------- | ------ | -------- | - | ------ |  | - | -------
|                                  |  | Licenses |        | Services |   | Total 
|Three months ended March 31, 2005 |  |          |        |          |   |        |  |   |        
|Revenues                          |  | $        | 54,718 |          | $ | 48,630 |  | $ | 103,348
|Cost of Revenues                  |  |          | 3,223  |          |   | 8,675  |  |   | 11,898 
|                                  |  |          |        |          |   |        |  |   |        
|Gross profit                      |  | $        | 51,495 |          | $ | 39,955 |  | $ | 91,450 
|                                  |  |          |        |          |   |        |  |   |        
|Three months ended March 31, 2004 |  |          |        |          |   |        |  |   |        
|Revenues                          |  | $        | 47,028 |          | $ | 35,499 |  | $ | 82,527 
|Cost of Revenues                  |  |          | 2,528  |          |   | 6,403  |  |   | 8,931  
|                                  |  |          |        |          |   |        |  |   |        
|Gross profit                      |  | $        | 44,500 |          | $ | 29,096 |  | $ | 73,596 
|                                  |  |          |        |          |   |        |  |   |        



10



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##### Table of Contents

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



|                                   |  |               |         |                |   |                        |  |       |        |  |   |        
|---------------------------------- |  | ------------- | ------- | -------------- | - | ---------------------- |  | ----- | ------ |  | - | -------
|                                   |  | United States |         | United Kingdom |   | OtherInternational (b) |  | Total
|Three months ended March 31, 2005: |  |               |         |                |   |                        |  |       |        |  |   |        
|Revenues                           |  | $             | 64,794  |                | $ | 13,270                 |  | $     | 25,284 |  | $ | 103,348
|Long-lived assets (a)              |  | $             | 196,328 |                | $ | 1,962                  |  | $     | 3,734  |  | $ | 202,024
|                                   |  |               |         |               
|Three months ended March 31, 2004: |  |               |         |                |   |                        |  |       |        |  |   |        
|Revenues                           |  | $             | 54,970  |                | $ | 8,888                  |  | $     | 18,669 |  | $ | 82,527 
|Long-lived assets (a)              |  | $             | 237,755 |                | $ | 1,218                  |  | $     | 3,769  |  | $ | 242,742



|(a) | Excludes goodwill and amortizing intangible assets, net.
|--- | --------------------------------------------------------



|(b) | No single country within Other International accounts for greater than 7% of revenues.
|--- | --------------------------------------------------------------------------------------



10. Commitments and Contingencies



In December 2004, we entered into an agreement to purchase a building located in Aliso Viejo, California, adjacent to our existing Aliso Viejo building,
comprising approximately 89,000 square feet for approximately $19 million. The completion of the purchase is expected to occur by May 31, 2005.



In March 2005, we settled our lawsuit with Computer Associates International, Inc. for $16.0 million plus royalties under a non-exclusive license
agreement. The settlement was fully accrued for in fiscal 2004 and did not impact our operating results for the current quarter. We have resumed marketing and licensing of our Quest Central for DB2 products and providing full support for this
solution to our customers.



We are a party to a variety of
immaterial litigation proceedings and claims, either asserted or unasserted, which we consider to be routine and incidental to our business. While the outcome of any of these matters cannot be predicted with certainty, we do not believe the outcome
of any of these proceedings or claims will have a material adverse effect on our consolidated financial position, results of operations or cash flows.



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, (iv) indemnities to our
directors and officers to the maximum extent permitted under applicable law, and (v) letters of credit and similar obligations as a form of credit support for our international subsidiaries and certain resellers. 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 our financial statements
included in this report, as the estimated fair value of these obligations as of March 31, 2005 was considered nominal.



11



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##### Table of Contents

11. Related Party Transactions; Subsequent Event



On March 17, 2004, we acquired Aelita Software Corporation. See Note 3 above. Certain venture capital funds associated with
Insight Venture Partners (the Insight Funds) previously holding shares of Aelitas preferred stock became entitled to receive (subject to claims against an indemnity escrow fund) approximately $47.6 million in cash in respect of
those shares of preferred stock as a result of this acquisition.



On April 26, 2005, Quest Software entered into an Agreement and Plan of Merger with Imceda Software, Inc. (Imceda), a privately held company that provides systems, storage and database management solutions, contemplating the
acquisition of Imceda by Quest in a transaction valued at approximately $60.6 million, of which 20% will be paid to Imcedas stockholders in Quest Software Common Stock. Closing of the contemplated transaction is subject to customary closing
conditions, including expiration of the applicable Hart-Scott-Rodino waiting period, and is expected to be completed by the end of the second quarter of 2005. We expect to fund the cash portion of the consideration to be paid in this acquisition
from our available cash and marketable securities and cash generated from operations. The Insight Funds hold shares of Imcedas preferred stock, and will be entitled upon the closing of the transaction to receive (in respect of those shares of
preferred stock) cash and (subject to claims against an indemnity escrow fund) shares of Quest Software common stock representing an aggregate value (based on the manner in which Quest Software common stock is valued under the Agreement and Plan of
Merger) of approximately $47.3 million.



Jerry Murdock, a
director of Quest Software, is a Managing Director and the co-founder of Insight Venture Partners and an investor in the Insight Funds. Vincent Smith, Quests Chairman of the Board and CEO, and Ray Lane and Paul Sallaberry, directors of Quest
Software, are passive limited partners in Insight Funds and, as a result, have interests in the Aelita transaction and the proposed Imceda transaction which are considered to be not material.



12



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##### Table of Contents

|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 (MD&A) also should be read in conjunction with the
consolidated financial statements and notes to those statements included elsewhere in this Report. Certain statements in this Report, including statements regarding our business strategies, operations, financial conditions and prospects, are
forward-looking statements. Use of the words believe, expect, anticipate, will, contemplate, would and similar expressions that contemplate future events may identify
forward-looking statements.



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



Overview and Business Model



Quest Software designs, develops, sells and supports software products that improve the performance and productivity of our customers packaged and
custom software applications and associated software infrastructure components such as databases, application servers and operating systems. Quest fits generally into a category of software companies referred to as Independent Software
Vendors, or ISVs, which are companies whose products support other vendors software or hardware products. We both internally develop and acquire our products. Our major product areas are Database Management, Windows
Management, and Application Management.



13



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##### Table of Contents

Our revenue consists primarily of software license fees and maintenance fees from customers. Our
software-licensing model is primarily based on perpetual license fees, and our license fees are typically calculated either on a per-server basis or a per seat basis, depending on the product. Maintenance contracts entitle a customer to technical
support via telephone and the internet and unspecified maintenance releases, updates and enhancements. First-year maintenance contracts are typically sold with the related software license and renewed on an annual basis thereafter. Annual
maintenance renewal fees are priced as a percentage of the net initial purchase fee of a perpetual license and first year maintenance. Maintenance revenue is based on vendor-specific objective evidence of fair value and amortized over the term of
the maintenance contract, typically 12 months. We also provide consulting and training services, which relate to installation of our products and do not include significant customization to or development of the underlying software code. Consulting
and training service revenues are recognized as the services are performed and represent approximately 12% of total services revenues for the three months ended March 31, 2005.



We invest heavily in research and development in order to design and develop a wide variety of products and technologies
that will be attractive to customers. In addition, we are a direct-sales driven organization that expends significant selling costs in order to secure new customer license sales and the follow-on maintenance revenue stream that can continue forward
beyond the initial license sale.



Quarterly Update



As discussed in more detail throughout our MD&A:



| |  |  | Results of operations in the three months ended March 31, 2005 improved over the comparable period in 2004, as indicated by higher total revenues, higher income from operations as a
percentage of total revenues (operating margin), higher income from operations and higher net income.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Total revenues increased 25.2% to $103.3 million and total expenses increased 12.1% to $88.4 million, resulting in an increase in operating margins of 1,010 basis points to 14.5%
from 4.4%. Income from operations increased to $14.9 million from $3.6 million and net income increased to $9.0 million from $0.4 million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Specific contributors to first quarter of 2005 revenue growth are discussed below in Results of Operations. In summary, our Microsoft Systems Management and Development
and Deployment product families, combined with strong cash collections in respect of license transactions on which we recognize revenue upon receipt of payment, were the primary contributors to revenue growth. License and services revenue growth
from our North American operations and Rest of World operations, primarily Europe, are provided below. Our Rest of World operations were the largest contributors to total revenue growth both on an absolute and percentage increase basis.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Products acquired in our March 2004 acquisition of Aelita Software Corporation, some of which replaced existing Quest products, contributed materially to total revenue growth in the
three months ended March 31, 2005 compared to the same period in 2004 mainly because a full quarter of Aelita operations were included in 2005 compared to only two weeks in 2004. We estimate Aelitas contribution to our overall growth in total
revenues in the first quarter of 2005 to be approximately $6.5 million, or 30%. Results of operations from Aelita and other acquisitions are included in our consolidated statements of operations from the respective dates of acquisition. We expect to
continue to evaluate a variety of strategic investment and acquisition opportunities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In September 2004, we sold our Vista Plus output management product line and related assets and certain customer support obligations to Open Text Corporation. The Vista Plus output
management product line generated approximately $3.9 million in total revenues in the three months ended March 31, 2004, the majority of which was maintenance revenue.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



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##### Table of Contents

| |  |  | Devaluation of the U.S. Dollar, from the first quarter of 2004 to the comparable period in 2005, relative to non-dollar currencies, primarily the Euro, Canadian Dollar and the
British Pound, contributed approximately $0.6 million to growth in total revenues and approximately $0.4 million to growth in operating expenses in the three months ended March 31, 2005. Foreign currency losses of $2.9 million during the first
quarter of 2005 resulted in a net loss on our other (expense) income, net line item.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our primary expenses are our personnel costs, which include compensation and benefits and costs of office facilities and travel and entertainment, which are a function of our
world-wide headcount. We estimate that these personnel related costs represented approximately 75% of total expenses in the three months ended March 31, 2005. Our total headcount, including temps and contractors, was approximately 2,404 and 2,197 at
March 31, 2005 and 2004, respectively.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Under the pending new accounting rules for stock-based compensation, we will begin to expense outstanding and newly granted stock options in January of 2006. This will substantially
increase our stock-based compensation expense, a non-cash expense, and will substantially reduce our operating margins.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We generated net cash from operating activities of $27.6 million in the first three months of 2005, and had $297.7 million in cash, cash equivalents and marketable securities at
March 31, 2005. We had no outstanding debt, with our long-term liabilities comprised of primarily long-term deferred revenue.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2005, we settled our lawsuit with Computer Associates International, Inc. for $16.0 million plus royalties under a non-exclusive license agreement. The settlement was fully
accrued for in fiscal 2004 and did not impact our operating results for the current quarter. We have resumed marketing and licensing of our Quest Central for DB2 products and providing full support for this solution to our customers. Total revenue
contribution from these products in the first quarter of 2004 was approximately 6% versus approximately 1% in the comparable period of 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Research and Development expense and the corresponding net income amounts as reported in this Form 10-Q reflect an adjustment to our preliminary Q1 2005 operating results announced
on May 4, 2005 (and included in our Current Report on Form 8-K filed the same day). These changes, which increased research and development expense by $229,000, reduced income from operations by $229,000 and reduced net income after tax by $154,000,
were made to correct an immaterial error in stock-based compensation expense (a non-cash charge) discovered after our earnings release but before our Form 10-Q filing.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



Except as otherwise indicated, the following are percentage of total revenues:



|                                                  |  |                             |   |  |       |  
|------------------------------------------------- |  | --------------------------- | - |  | ----- | -
|                                                  |  | Three Months EndedMarch 31, |  
|                                                  |  | 2005                        |   |  | 2004  |  
|Revenues:                                         |  |                             |   |  |       |  
|Licenses                                          |  | 52.9                        | % |  | 57.0  | %
|Services                                          |  | 47.1                        |   |  | 43.0  |  
|                                                  |  |                             |   |  |       |  
|Total revenues                                    |  | 100.0                       |   |  | 100.0 |  
|                                                  |  |                            
|Cost of revenues:                                 |  |                             |   |  |       |  
|Licenses                                          |  | 0.9                         |   |  | 1.3   |  
|Services                                          |  | 8.4                         |   |  | 7.8   |  
|Amortization of purchased technology              |  | 2.2                         |   |  | 1.7   |  
|                                                  |  |                             |   |  |       |  
|Total cost of revenues                            |  | 11.5                        |   |  | 10.8  |  
|                                                  |  |                             |   |  |       |  
|Gross profit                                      |  | 88.5                        |   |  | 89.2  |  
|                                                  |  |                            
|Operating expenses:                               |  |                             |   |  |       |  
|Sales and marketing                               |  | 42.0                        |   |  | 43.8  |  
|Research and development                          |  | 20.4                        |   |  | 22.0  |  
|General and administrative                        |  | 9.4                         |   |  | 10.0  |  
|Amortization of other purchased intangible assets |  | 1.2                         |   |  | 0.9   |  
|In-process research and development               |  | 1.0                         |   |  | 8.1   |  
|                                                  |  |                             |   |  |       |  
|Total operating expenses                          |  | 74.0                        |   |  | 84.8  |  
|                                                  |  |                             |   |  |       |  
|Income from operations                            |  | 14.5                        |   |  | 4.4   |  
|Other (expense) income, net                       |  | (1.5                        | ) |  | 0.8   |  
|                                                  |  |                             |   |  |       |  
|Income before income taxes                        |  | 13.0                        |   |  | 5.2   |  
|Income tax provision                              |  | 4.2                         |   |  | 4.7   |  
|                                                  |  |                             |   |  |       |  
|Net income                                        |  | 8.8                         | % |  | 0.5   | %
|                                                  |  |                             |   |  |       |  
|As a percentage of related revenues:              |  |                             |   |  |       |  
|Cost of licenses                                  |  | 1.8                         | % |  | 2.3   | %
|Cost of services                                  |  | 17.8                        | % |  | 18.0  | %



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##### Table of Contents

Comparison of Three Months Ended March 31, 2005 and 2004



Revenues



Total revenues and year-over-year changes are as follows (in thousands, except for percentages):



|                       |  |                             |         |          |   |         |  |            |        |  |      |  
|---------------------- |  | --------------------------- | ------- | -------- | - | ------- |  | ---------- | ------ |  | ---- | -
|                       |  | Three Months EndedMarch 31, |         | Increase |  
|                       |  | 2005                        |         | 2004     |   | Dollars |  | Percentage |       
|Revenues:              |  |                             |         |          |   |         |  |            |        |  |      |  
|Licenses               |  |                             |         |          |   |         |  |            |        |  |      |  
|North America          |  | $                           | 33,894  |          | $ | 33,564  |  | $          | 330    |  | 1.0  | %
|Rest of World          |  |                             | 20,824  |          |   | 13,464  |  |            | 7,360  |  | 54.7 | %
|                       |  |                             |         |          |   |         |  |            |        |  |      |  
|Total license revenues |  |                             | 54,718  |          |   | 47,028  |  |            | 7,690  |  | 16.4 | %
|                       |  |                             |         |          |   |         |  |            |        |  |      |  
|Services               |  |                             |         |          |   |         |  |            |        |  |      |  
|North America          |  |                             | 34,816  |          |   | 26,286  |  |            | 8,530  |  | 32.5 | %
|Rest of World          |  |                             | 13,814  |          |   | 9,213   |  |            | 4,601  |  | 49.9 | %
|                       |  |                             |         |          |   |         |  |            |        |  |      |  
|Total service revenues |  |                             | 48,630  |          |   | 35,499  |  |            | 13,131 |  | 37.0 | %
|                       |  |                             |         |          |   |         |  |            |        |  |      |  
|Total revenues         |  | $                           | 103,348 |          | $ | 82,527  |  | $          | 20,821 |  | 25.2 | %
|                       |  |                             |         |          |   |         |  |            |        |  |      |  



Licenses Revenues Growth in license revenues is primarily a result of increased software license sales within our Microsoft Systems Management product line, of which our Aelita products contributed approximately one-half of the overall license revenues
growth. The license revenues contribution from the acquired Aelita products have become less identifiable because we have created product suites comprising both Aelita and Quest Microsoft Systems Management products and because in some cases Aelita
products have replaced comparable Quest products. North American license revenues from our Microsoft Systems Management product line was approximately 45% higher in the first quarter of 2005 over the comparable period in 2004, but was offset
entirely by the fact that we had significantly reduced revenue contribution during the first quarter of 2005 from our Quest Central for DB2 products (affected by the preliminary injunction issued in our litigation with Computer Associates) and our
former Vista Plus output management products (which were sold during the third quarter of 2004). We noted particular strength in license revenues growth from our Microsoft Systems Management products in EMEA, which increased by approximately 123%
from the first quarter of 2004 to the comparable period in 2005. To a lesser extent, our Development and Deployment product line contributed to growth in license revenues, increasing by 15% over the prior year and also showing particular strength in
EMEA. Our strong cash collection efforts on license transactions on which we recognize revenue upon receipt of payment also contributed to license revenues growth.



Services Revenues The largest component of service revenues is maintenance revenue. Service revenues also
include fees for consulting and training services. Three factors were the primary contributors to our 37.0% growth in service revenues. First, from a product perspective, our Microsoft Systems Management product line contributed approximately $6.4
million to growth in service revenues. Second, maintenance revenues from renewals of annual maintenance agreements have continued to grow. Third, revenues from post-sales consulting and training increased $1.6 million or 35.1%. Post-sales consulting
and training as a percentage of total service revenues represented 12.3% and 12.5% in the three months ended March 31, 2005 and 2004, respectively. Our Vista Plus output management product line, sold in September 2004, generated approximately $2.5
million of our North American first quarter 2004 services revenues. Excluding Vista Plus, our North American service revenues increased by 42%.



As our software maintenance customer base grows, the renewal rate has a larger influence on the software maintenance revenue growth rate and the amount of
new software license revenues has a diminishing effect. Therefore, the growth rate of software maintenance revenues does not necessarily correlate directly to the growth rate of new software license revenues in a given period. The primary
determinant of changes in our software maintenance revenue profile is the rate at which our customers renew their annual maintenance and support agreements. If our maintenance renewal rates were to decline materially, our maintenance revenues and
total revenues would likely decline materially as well. Although we do not currently expect our maintenance renewal rates to deteriorate, there can be no assurance they will not.



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Cost of Revenues



Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):



|                                     |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|------------------------------------ |  | --------------------------- | ------ | ------------------- | - | ------- |  | - | ---------- | - |  | ----- | --
|                                     |  | Three Months EndedMarch 31, |        | Increase/(Decrease) |  
|                                     |  | 2005                        |        | 2004                |   | Dollars |  |   | Percentage |  
|Cost of revenues:                    |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|Licenses                             |  | $                           | 968    |                     | $ | 1,097   |  | $ | (129       | ) |  | (11.8 | )%
|Services                             |  |                             | 8,675  |                     |   | 6,403   |  |   | 2,272      |   |  | 35.5  | % 
|Amortization of purchased technology |  |                             | 2,255  |                     |   | 1,431   |  |   | 824        |   |  | 57.6  | % 
|                                     |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|Total cost of revenues               |  | $                           | 11,898 |                     | $ | 8,931   |  | $ | 2,967      |   |  | 33.2  | % 
|                                     |  |                             |        |                     |   |         |  |   |            |   |  |       |   



Cost of Licenses Cost of licenses primarily consists of third-party software royalties, product packaging, documentation, duplication, delivery and personnel costs. Cost of licenses as a percentage of license revenues was 1.8% and 2.3% for the three
months ended March 31, 2005 and 2004, respectively. The percentage of revenue decrease is primarily the result of reduced license revenues from sales of licenses to royalty-bearing products.



Cost of Services Cost of services primarily consists of
personnel, outside consultants, facilities and systems costs used in providing support, consulting and training services. Personnel related costs, such as labor, bonuses, vacation and payroll taxes, increased by approximately $1.5 million. This rise
in personnel related costs is primarily due to a significant increase in headcount, including the additional headcount from the acquisition of Aelita. Consulting fees paid to outside professional services consultants in support of product
deployments increased by $0.2 million. Cost of services as a percentage of service revenues was 17.8% in the three months ended March 31, 2005, compared to 18.0% in the comparable period of 2004.



Amortization of Purchased Technology Amortization of purchased
technology includes amortization of the fair value of acquired technology associated with acquisitions made since 2001. We expect amortization of purchased technology to be at least $6 million for the remaining three quarters of 2005.



Operating Expenses



Total operating expenses and year-over-year changes are as follows (in thousands, except for percentages):



|                                                  |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|------------------------------------------------- |  | --------------------------- | ------ | ------------------- | - | ------- |  | - | ---------- | - |  | ----- | --
|                                                  |  | Three Months EndedMarch 31, |        | Increase/(Decrease) |  
|                                                  |  | 2005                        |        | 2004                |   | Dollars |  |   | Percentage |  
|Operating expenses:                               |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|Sales and marketing                               |  | $                           | 43,393 |                     | $ | 36,124  |  | $ | 7,269      |   |  | 20.1  | % 
|Research and development                          |  |                             | 21,120 |                     |   | 18,158  |  |   | 2,962      |   |  | 16.3  | % 
|General and administrative                        |  |                             | 9,702  |                     |   | 8,260   |  |   | 1,442      |   |  | 17.5  | % 
|Amortization of other purchased intangible assets |  |                             | 1,276  |                     |   | 730     |  |   | 546        |   |  | 74.8  | % 
|In-process research and development               |  |                             | 1,050  |                     |   | 6,700   |  |   | (5,650     | ) |  | (84.3 | )%
|                                                  |  |                             |        |                     |   |         |  |   |            |   |  |       |   
|Total operating expenses                          |  | $                           | 76,541 |                     | $ | 69,972  |  | $ | 6,569      |   |  | 9.4   | % 
|                                                  |  |                             |        |                     |   |         |  |   |            |   |  |       |   



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 for personnel; sales commissions; facilities and Information Systems (IS);
trade shows; travel and entertainment; and marketing communications programs. Personnel related costs, such as labor, bonuses, vacation and payroll taxes, increased approximately $5.5 million. This increase in personnel related expenses is primarily
due to a significant increase in headcount, including the additional headcount from the acquisition of Aelita. Marketing communications and program expenses increased by approximately $1.0 million. A portion of the overall increase was offset by a
reduction of approximately $0.8 million to depreciation expense related to our sales force automation system, implemented in 2001 and fully depreciated by the end of the third quarter in 2004. Sales and marketing expenses as a percentage of total
revenues were 42.0% and 43.8% in 2005 and 2004, respectively. In the three months ended March 31, 2005, the decline of the U.S. Dollar from the first quarter of 2004 to the comparable period in 2005, primarily against the Euro and the British Pound,
contributed approximately $0.4 million to the year-over-year increase in sales and marketing expenses.



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 IS costs and payments made to outside software development consultants in connection with our ongoing efforts to enhance our core
technologies and develop additional products. Compensation and benefit costs, such as labor, bonuses, severance, vacation and payroll taxes, increased approximately $2.0 million. This rise in personnel related expenses is primarily due to a
significant increase in headcount, including the additional headcount from the acquisition of



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Aelita. Research and development expenses as a percentage of total revenues were 20.4% and 22.0% for the three months ended March 31, 2005 and 2004,
respectively.



General and Administrative General
and administrative expenses consist primarily of compensation and benefit costs for our executive, finance, legal, administrative and IS personnel, professional fees for audit, tax and legal services, and associated facilities and IS costs.
Compensation and benefit costs, such as labor, bonuses, temporary labor and payroll taxes, increased approximately $1.4 million. This rise in personnel related costs are primarily due to a significant increase in headcount. Higher accounting and tax
fees related to our ongoing SOX 404 compliance efforts also contributed approximately $0.5 million to the 17.5% increase in general and administrative expenses as the first quarter of 2004 was a light spend quarter on SOX related efforts. Legal
costs decreased by approximately $0.8 million as a result of the settlement or dismissal of litigation matters early in the first quarter of 2005. General and administrative expenses as a percentage of total revenues were 9.4% and 10.0% for the
three months ended March 31, 2005 and 2004, respectively.



Amortization of Other Purchased Intangible Assets Amortization of other purchased intangible assets includes the amortization of customer lists, trademarks, non-compete agreements and maintenance contracts associated with
acquisitions. We expect amortization of other purchased intangible assets to be at least $4 million for the remaining three quarters of 2005.



In-Process Research and Development In-process research and development expenses relate to in-process technology acquired from Wingra
Technologies, LLC in January 2005 and our acquisition of Aelita in March 2004. These costs were charged to operations as the technologies had not reached technological feasibility and did not have alternative future uses at the date of acquisition.



Other (Expense) Income, Net



Other (expense) income, net includes interest income on our investment
portfolio, and gains and losses from foreign exchange fluctuations, as well as gains or losses on other financial assets. Other (expense) income, net decreased from $0.7 million in the first quarter of 2004 to a loss of $(1.5) million in the
comparable period of 2005. Our net interest income was $1.9 million in the three months ended March 31, 2005 and 2004. Foreign currency losses were $2.9 million and $1.0 million in 2005 and 2004, respectively. Foreign currency losses were
predominantly attributable to translation losses on accounts receivable and cash denominated in primarily the Euro, and to a lesser extent, the British Pound and the Australian Dollar. The foreign currency translation adjustments to these balance
sheet items are calculated by comparing the currency spot rates on March 31, 2005 to the spot rates on December 31, 2004. On this basis the U.S. Dollar strengthened against the Euro, the British Pound and the Australian Dollar during the periods
presented.



Income Tax Provision



During the three months ended March 31, 2005, the provision for income taxes
increased to $4.4 million from $3.9 million in the comparable period of 2004, representing an increase of $0.5 million. The effective income tax rate for the three months ended March 31, 2005 and 2004 was approximately 33% and 91%, respectively. The
significant tax rate in the first quarter of 2004 was primarily due to a permanent difference between GAAP pre-tax income and taxable income as a result of a $6.7 million non-deductible write-off of Aelitas in-process research and development
in the three months ended March 31, 2004.



Liquidity and Capital Resources



Year-over-year changes in the principal components of our
liquidity and capital resources are as follows (in thousands, except for percentages):



|                                                               |  |                             |         |   |          |   |         |   |  |        |   
|-------------------------------------------------------------- |  | --------------------------- | ------- | - | -------- | - | ------- | - |  | ------ | --
|                                                               |  | Three Months EndedMarch 31, |         |   | % Change |  
|                                                               |  | 2005                        |         |   | 2004     |   |        
|Cash and cash equivalents and short-term marketable securities |  | $                           | 152,189 |   |          | $ | 84,063  |   |  | 81.0   | % 
|Long-term government and government agency securities          |  |                             | 145,511 |   |          |   | 180,688 |   |  | (19.5  | )%
|                                                               |  |                             |         |   |          |   |         |   |  |        |   
|Total cash, cash equivalents and securities investments        |  | $                           | 297,700 |   |          | $ | 264,751 |   |  | 12.4   | % 
|                                                               |  |                             |         |   |          |   |         |   |  |        |   
|Net cash provided by operating activities                      |  | $                           | 27,603  |   |          | $ | 22,752  |   |  | 21.3   | % 
|Net cash used in investing activities                          |  | $                           | (13,729 | ) |          | $ | (97,864 | ) |  | (86.0  | )%
|Net cash (used in) provided by financing activities            |  | $                           | (11,338 | ) |          | $ | 74,419  |   |  | (115.2 | )%



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Operating Activities



Our primary source of operating cash flows is cash collections from our customers following the purchase of new software licenses, maintenance and support
and post-sale consulting and training. Our primary use of cash from operating activities is for compensation and personnel-related expenditures.



During the three months ended March 31, 2005 and 2004 our cash flows from operations were primarily derived from (i) the positive net income generated
from our operations; (ii) changes in our working capital, including the 2005 cash payment of $16 million to settle our litigation with Computer Associates International, Inc. (CA); (iii) and the add-back of depreciation and amortization costs and
in-process research and development costs, which represent non-cash expenses.



Working capital changes in the 2005 period were mostly driven by strong cash collections on prior year-end accounts receivable. Our days sales outstanding (DSO), which is calculated by dividing period end accounts
receivable, net by average daily sales for the quarter, improved to 48 days in the three months ended March 31, 2005 compared to 56 days in the same period of 2004 and 75 days in the three months ended December 31, 2004. The decline in DSO is mostly
due to more timely collections. Improved collections resulted in $43.5 million of cash generated in the first quarter of 2005 versus $9.8 million during the comparable period of 2004. The substantial inflow of cash from accounts receivable
collections was partially offset by lower cash generation as a result of reduced deferred revenue, which primarily consists of maintenance and support, a $16 million cash payment made in settlement of our CA litigation and decreases in accrued
compensation, other accrued expenses and income taxes payable.



In the future, we expect cash will continue to be generated from our operations. We plan to use cash generated from operations to invest in short and long-term marketable securities consistent with past investment practices. We also plan to
use cash generated from operations to fund other strategic investment and acquisition opportunities that we continue to evaluate.



Investing Activities



Our primary source of cash provided by investing activities is from proceeds received from investments in marketable securities. Our primary uses of cash
from investing activities are from purchases of property, equipment, marketable securities and cash payments for acquisitions.



Cash used in investing activities in the three months ended March 31, 2005, consists of $12.8 million net cash paid for our acquisition of Wingra
Technologies, LLC and $3.0 million in capital expenditures, partially offset by $2.1 million of cash received from investments in marketable securities. Cash used in investing activities in the three months ended March 31, 2004, consists of $94.3
million net cash paid for the acquisition of Aelita, $16.6 million in capital expenditures, which includes the purchase of our first headquarters building in Aliso Viejo, California, partially offset by $13.0 million cash received from investments
in marketable securities.



On December 9, 2004, we entered into
an agreement to purchase a second building located in Aliso Viejo, California, adjacent to our existing Aliso Viejo building, comprising approximately 89,000 square feet for approximately $19 million. The completion of the purchase is expected to
occur by May 31, 2005. We expect the relocation of our remaining Irvine operations to this new building to be completed by the end of 2005 and anticipate costs of improvements to be approximately $10.0 million to $11.0 million.



Financing Activities



Our source of financing cash flow during the three months ended March 31, 2005 is from issuance of our common stock under
our employee stock option plan. Our primary use of cash in financing activities was for repayment of our repurchase agreement, as described below.



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We entered into a repurchase agreement in March 2004 with the $67.5 million in cash proceeds used to
provide funding for our acquisition of Aelita and our purchase of a new office facility. Our remaining obligation under this agreement of $12.7 million was paid in full in February 2005.



Our Board of Directors authorized a stock repurchase program for up to five million shares of our common stock. As of March
31, 2005, we had repurchased approximately 1.7 million shares of our common stock under this program for an aggregate cost of approximately $58.0 million. No shares of common stock have been repurchased under this program since 2002.



Based on our current operating plan, we believe that our existing cash, cash
equivalents, investment balances and cash flows from operations will be sufficient to finance our cash needs through at least the next 12 to 24 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 and other cash requirements. Our ability to generate cash from operations is subject to substantial risks described below under the captionRisk Factors. During the second quarter of 2005, we expect to spend approximately $22 million in cash to complete the purchase of a second building in Aliso Viejo, California and related infrastructure improvements and $48 million in
cash to complete the proposed acquisition of Imceda Software, Inc. Cash could also be used in the future for additional acquisitions or strategic investments. If additional funds are required to support our working capital requirements or for other
purposes we may seek to raise funds through public or private equity or debt financing or from other sources. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional
financing on terms favorable to us.



Critical Accounting Policies and
Estimates



Our consolidated financial statements are based
on the selection and application of generally accepted accounting principles, which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future
events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial
statements. We believe that the policies set forth below may involve a higher degree of judgment and complexity in their application than our other accounting policies and represent the critical accounting policies and estimates used in the
preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results. Historically, our assumptions, judgments and estimates relative to our critical
accounting policies and estimates have not differed materially from actual results. Our significant accounting policies are presented in our Annual Report on Form 10-K for the year ended December 31, 2004. There have been no changes to our
significant accounting policies or critical accounting policies and estimates during the three months ended March 31, 2005.



Revenue Recognition



We recognize revenue in accordance with current generally accepted accounting principles that have been prescribed for the software industry. Our revenue
recognition policy is one of our critical accounting policies because revenue is a key component of our results of operations and is based on complex rules, which require us to make judgments and estimates. In applying our revenue recognition policy
we must determine which portions of our revenue are recognized currently and which portions, if any, must be deferred. We analyze various factors, including our pricing policies, the credit-worthiness of our customers, contractual terms and
conditions, our historical experience and market and economic conditions. Changes in judgments on these factors could materially impact the timing and amount of revenue and costs recognized.



Our revenues consist of software license revenues, maintenance revenues and
professional services revenues. Our revenue recognition policies for these revenue categories are as follows.



We sell our products primarily through direct sales. In addition, almost all of our software license revenues are from sales of perpetual licenses. The
fee for one year of maintenance and support services is included in the initial purchase fee for a perpetual license of a Quest product, so that the purchase of a perpetual license with first year maintenance and support services is a
multi-element arrangement for revenue recognition purposes. We offer customers the right to purchase maintenance and support services on a standalone basis for annual periods beyond the first year.



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We account for the perpetual license component of these multiple-element arrangements using the residual
method. The residual method generally requires recognition of software license revenue in a multiple-element arrangement once all software products have been delivered to the customer and the only undelivered element is PCS (post contract support,
or maintenance) and/or certain services. The value of the undelivered maintenance services is determined based on VSOE (vendor-specific, objective evidence) and is deferred and recorded to revenue ratably over the maintenance term. The residual
revenue is allocated to the license fees associated with the software product or products being licensed in the transaction, based on the relative list prices. Our maintenance and support services VSOE of fair value is determined by reference
to the price our customers pay for the services when sold separately; that is, the maintenance and support renewal fees paid by our customers. Annual maintenance and support renewal fees are generally priced as a percentage of the initial discounted
purchase price and are recognized ratably over the maintenance periods, generally one year.



In addition to perpetual licenses, we sell a small amount of subscription software licenses each year. Less than 2% of total revenue for the three months ended March 31, 2005 was generated by subscription software
licenses. Software subscriptions are term based and the customer pays a single fee for the right to use the software and receive maintenance and support services for the term. A subscription sales license and maintenance and support fee
components are both deferred and recognized ratably over the license term. For indirect sales transactions, we accept orders from our distributors and resellers when they have existing, valid orders from an end customer user. We defer revenue
recognition on these indirect sales until receipt of payment unless we have an adequate payment history with the reseller or distributor with no late payment experiences. Resellers have no product return rights.



A customers renewal of post-contract support services is for an annual
period and is priced as a percentage of the net initial purchase fee of a perpetual license and first year post-contract support. We bill this renewal fee in advance of the services provided. Both first year and renewal post-contract support fees
are recognized ratably over the 12-month support period. We also offer customers the right to purchase post-contract support services for multiple annual periods beyond the first year, and we recognize these fees ratably over the support periods.



Our professional services fees are generally derived from
time-and-materials based arrangements that typically range on average from five to fifteen days in duration. These services are generally implementation and training services. Revenue is recognized on such contracts as work is performed. We sell our
professional services both standalone and as part of multi-element arrangements. When professional services are sold as part of a multi-element arrangement, VSOE of fair value is based on established pricing and discounting practices for those
services when sold separately.



Historically, we have been able
to establish VSOE for customer support and professional services, but we may modify our pricing practices in the future, which could result in changes in, or the inability to support, VSOE of fair value for these undelivered elements. If this
occurs, our future revenue recognition for multi-element arrangements could differ significantly from our historical results. If in the future we were unable to support VSOE of fair value for an undelivered element, the entire amount of revenue from
the arrangement would be deferred and recognized ratably over the life of the contract.



For additional information regarding our revenue recognition accounting policy see Note 1 Description of Business and Summary of Significant Accounting Policies included in our Annual Report on Form
10-K for the year ended December 31, 2004.



Asset Valuation



Asset valuation includes assessing the recorded value
of certain assets, including accounts receivable, goodwill and other intangible assets. We use a variety of factors to assess valuation, depending upon the asset.



| |  |  | 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. This requires us to make estimates of future product returns, annual support cancellations and write-offs of bad debt accounts related to current period revenues. The amount of our reserves is based on historical experience and
our current analysis of the collectability of 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 unless we have breached the product warranty and are unable to cure the
breach. Our product warranties are typical industry warranties that a product will perform in accordance with established product requirements. 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Goodwill  Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. We performed our annual
impairment review in the fourth quarter of 2004 and, as a result, determined that the carrying value of each reporting unit was less than the estimated fair value of the reporting units. 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
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | impairment exist. Future impairment reviews may result in charges against earnings to write down the value of goodwill.
| | -----------------------------------------------------------------------------------------------------------------------



| |  |  | Intangible assets  These assets are recorded at the appraised value and amortized using the straight-line method over estimated useful lives of two years to seven years. The
net carrying amount of other intangible assets was considered recoverable at March 31, 2005. In accordance with SFAS No. 144, these intangible assets are reviewed for events or changes in circumstances, which indicate that their carrying value may
not be recoverable. We periodically review the carrying value of these assets to determine whether or not impairment to such value has occurred. In the event that in the future it is determined that the other 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Accounting for Income Taxes



As part of the process of preparing our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we
operate. U.S and foreign tax returns are subject to routine compliance reviews by the various tax authorities. We accrue for tax contingencies based upon our best estimate of the taxes we expect to pay. These estimates are updated over time as more
definitive information becomes available from taxing authorities, completion of tax audits or upon occurrence of other events. The tax contingency accrual is recorded as a component of our net income taxes payable/receivable balance.



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. U.S. income taxes were not
provided for on undistributed earnings from certain non-U.S. subsidiaries. Those earnings are considered to be permanently reinvested.



Recently Issued Accounting Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No.
123 (revised 2004), Share-Based Payment (SFAS 123R), that upon implementation, will impact our net income and net income per share and change the classification of certain elements in the statement of cash flows. SFAS
123R eliminates the alternative to use the intrinsic value method of accounting under SFAS No. 123 and supersedes Accounting Principles Board (APB) Opinion No. 25, and its related implementation guidance. Under APB Opinion 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. SFAS 123R will require us to measure all employee stock-based compensation awards
using a fair value method and record such amounts as an expense in our statement of operations, on a prospective basis, as the underlying options vest. In April 2005, the Securities and Exchange Commission amended the compliance dates for SFAS 123R
to require adoption at the beginning of fiscal years beginning after June 15, 2005. We are required to adopt SFAS 123R in our first quarter of 2006, with expensing to begin January 1, 2006. See Stock Based Compensation in Note 2
of the Notes to Condensed Consolidated Financial Statements for the pro forma net income and net income per share amounts, for the three months ended March 31, 2004 and 2005, as if we had used one of the fair-value-based methods,
similar to the methods available under SFAS 123R, to measure compensation expense for employee stock incentive awards. While we are still evaluating the requirements under and effects of SFAS 123R we expect the adoption to have a significant adverse
impact on our consolidated income from operations, net income and net income per share.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (FAS 109-1), Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004 (AJCA). The AJCA introduces a special 9% tax deduction on qualified production activities, which is phased in through 2010. FAS 109-1, clarifies that this tax
deduction should be accounted for as a special tax deduction in accordance with Statement 109. This provision may provide a tax benefit to us from both a financial



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statement effective tax rate perspective and as a deduction on our tax return, which may effectively reduce the amount of taxes owed.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-2
(FAS 109-2), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004. The AJCA introduces a limited time 85% dividends received deduction on the
repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. We expect to complete our evaluation of
the effects of the repatriation provision by the end of the third quarter of 2005.



In March 2004, the FASB issued EITF Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments which provided new guidance for
assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however
the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once final guidance is issued.



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RISK FACTORS



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



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



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



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



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



| |  |  | 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 recent accounting pronouncement requiring employee stock options to be accounted for using a fair-value method will materially reduce our reported operating margins, operating income, net income and net income
per share



We currently account for the issuance of stock
options under Accounting Principles Board (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. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which eliminates the alternative to use the
intrinsic value method of accounting under SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) and supersedes APB No. 25, and its related implementation guidance. SFAS 123R will



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require us to measure all employee stock-based compensation awards using a fair value method and record such amounts as an expense in our statement of
operations. We are required to adopt SFAS 123R in our first quarter of 2006, beginning January 1, 2006. The additional expense associated with stock options will be substantial and will materially reduce our operating margins, operating income, net
income and net income per share. These reductions in our operating results may result in a reduction to our stock price and market value, the magnitude of which cannot be determined. Note 2 of the Notes to Condensed Consolidated Financial
Statements contains a detailed presentation of our current methods of accounting for stock-based compensation plans and includes pro forma fair value disclosures currently required under SFAS No. 123.



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 delivered 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 SharePlex, can last from three to nine months and often require
pre-purchase evaluation periods and customer education, which can affect timing of orders. Further, we have often booked a large amount of our sales in the last month, weeks or days of each quarter and delays in the closing of sales near the end of
a quarter could cause quarterly revenue to fall short of anticipated levels. Finally, while a portion of our revenues each quarter is recognized from previously deferred revenue, our quarterly performance will depend primarily upon entering into new
contracts to generate revenues for that quarter. These factors may cause significant periodic variation in our license revenues. In addition, we incur or commit to operating expenses based on anticipated revenue levels, and generally do not know
whether revenues in any quarter will meet expectations until the end of that quarter. Accordingly, if our revenue growth rates slow or our revenues decline, our operating results could be seriously impaired because many of our expenses are
relatively fixed in nature and cannot be easily or quickly changed.



General
economic conditions and 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 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. Competition from Oracle with certain of our Database Management products
including SharePlex and Quest Central for Oracle has increased over the last two years and has continued to increase with Oracles introduction of the next version of its database, known as Oracle 10G. Oracle 10G has enhanced capabilities in
the functions competitive with SharePlex, Quest Central for Oracle and with the Oracle monitoring capabilities of Foglight. We believe increased competition from Oracle has materially depressed our SharePlex and Quest Central for Oracle revenues
over the last three years.



In some cases these platform
vendor-provided tools are bundled with the platform and in other cases they are separately chargeable products, albeit at significantly lower price points. The inclusion of the functionality of our software as standard features of the underlying
database solution or application supported by our products or sale at much lower cost could erode our revenues, particularly if the competing products and features were of comparable capability to our products. Even if the functionality provided as
standard features or lower costs by these system providers is more limited than that of our software, there can be no assurance that a significant number of customers would not elect to accept more limited functionality in lieu of purchasing our
products. Moreover, there is substantial risk that the mere announcements of competing products or features by large competitors such as Oracle could result in the delay or cancellation of customer orders for our products in anticipation of the
introduction of such new products or features.



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Our migration products for Microsofts Active Directory and Exchange are vulnerable to fluctuations in the rate
at which customers of certain Microsoft products migrate to newer versions of such products



Our products for the migration, administration and management of Microsofts Active Directory and Exchange products currently contribute
approximately one-third of our revenue from software license sales and have been the primary contributors to license revenue growth in fiscal 2003, 2004 and the first three months of 2005. Our ability to sell licenses for our Active Directory and
Exchange migration products depends in part on the rate at which customers migrate to newer versions of Microsofts Windows 2000 or Windows XP operating system or to newer versions of Microsoft Exchange. If these migration rates were to
materially decrease, our license revenues from these migration products would likely decline.



Many of our products are dependent on database or application technologies of others; if these technologies lose market share or become incompatible with our products, or if these vendors introduce competitive
products or acquire or form strategic relationships with our competitors, 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 relationships with providers of
major database and enterprise software programs, including Oracle, IBM, Microsoft, SAP and Siebel. Our competitive advantage consists in substantial part on the integration between our products and products provided by these major software
providers, and our extensive knowledge of their products and technologies. If these companies for any reason decide to promote technologies and standards that are not compatible with our technologies, or if they lose market share for their database
or application products, our business, operating results and financial condition would be materially adversely affected. Furthermore, these major software vendors could attempt to increase their presence in the markets we serve by either introducing
products that compete with our products or acquiring or forming strategic alliances with our competitors. These companies have longer operating histories, larger installed bases of customers and substantially greater financial, distribution,
marketing and technical resources than we do, as well as well-established relationships with many of our present and potential customers, and may be in better position to withstand and respond to the current factors impacting this industry. As a
result, we may not be able to compete effectively with these companies 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. 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.



Failure to maintain
effective internal control over financial reporting could adversely affect the price of our common stock



Pursuant to rules adopted by the SEC implementing Section 404 of the Sarbanes-Oxley Act of 2002, we are required to assess the effectiveness of our
internal controls over financial reporting and report whether such internal controls are effective. Our auditors must issue an attestation report on such assessment. Accordingly, we have undertaken to evaluate, test and remediate, if necessary, our
internal controls pursuant to a clearly defined internal plan and schedule. Although we believe that our efforts will enable us to provide the required report and our independent auditors to provide the required attestation as of the end of each
fiscal year, there can be no assurance that our assessment will conclude that our internal control over financial reporting is effective. For example, our managements assessment for the year ended December 31, 2004 identified a material
weakness in our internal control over financial reporting with respect to our calculations for the provision of income taxes. As a result, our management has concluded that our internal control over financial reporting was not effective as of the
end of our fiscal 2004. SeeManagements Report on Internal Control Over Financial Reporting in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2004 for more information on this matter.



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This material weakness, and any future weakness or deficiency in our internal control over financial reporting could adversely affect the market price of our
common stock.



Intense competition in the markets for our products could
adversely affect our results of operations



The markets
for our products are highly competitive. As a result, our future success will be affected by our ability to, among other things, outperform our competitors in meeting the needs of current and prospective customers and identifying and addressing new
technological and market opportunities. Our competitors may develop more advanced technology, adopt more aggressive pricing policies and undertake more effective sales and marketing campaigns and may be able to leverage more extensive financial,
technical or partner resources. If we are unable to maintain our competitive position, our revenues may decline and our operating results may be adversely affected.



Our operating results may be negatively impacted by fluctuations in foreign currency exchange rates



Our international operations are generally conducted through our
international subsidiaries, with the associated revenues and related expenses, and balance sheets, denominated in the currency of the country in which the international subsidiaries operate. As a result, our operating results may be harmed by
fluctuations in exchange rates between the U.S. Dollar and other foreign currencies. The foreign currencies to which we currently have the most significant exposure are the Canadian Dollar, the British Pound, the Euro and the Australian Dollar. To
date, we have not used derivative financial instruments to hedge our exposure to fluctuations in foreign currency exchange rates.



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



We maintain research and development operations in Canada, Australia, Israel
and Russia, and 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, managing and operating our foreign operations;
| | - |  | ------------------------------------------------------------------------



| |  |  | difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | longer payment cycles and difficulties in collecting accounts receivable;
| | - |  | -------------------------------------------------------------------------



| |  |  | seasonal reductions in business activity during the summer months in Europe and in other periods in other countries;
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | increased financial accounting and reporting burdens and complexities;
| | - |  | ----------------------------------------------------------------------



| |  |  | difficulties in hedging foreign currency transaction exposures;
| | - |  | ---------------------------------------------------------------



| |  |  | limitations on future growth or inability to maintain current levels of revenue from international operations if we do not invest sufficiently in our international operations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | our ability to adapt and conform to accepted local business practices and customs, including providing letters of credit or other forms of support to or for the benefit of our
subsidiaries or resellers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | compliance with a wide variety of complex foreign laws and treaties, including employment restrictions; and
| | - |  | -----------------------------------------------------------------------------------------------------------



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



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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.



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. 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. If we are unable to fully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of an acquisition.



We face risks associated with governmental contracting



We derive a portion of our revenues from contracts with the United States
government and its agencies and from contracts with state and local governments or agencies. Demand and payment for our products and services are impacted by public sector budgetary cycles and funding availability, with funding reductions or delays
adversely impacting public sector demand for our products and services. Public sector customers may also change the way they procure new contracts and may adopt new rules or regulations governing contract procurement, including required competitive
bidding or use of open source products, where available. These factors may limit the growth of or reduce the amount of revenues we derive from the public sector, which could negatively affect our results of operations.



Our efforts to constrain costs may strain our management, administrative, operational and
financial infrastructure



We 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 increasingly complex 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 the three months ended March 31, 2004 to the comparable period in 2005, 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.



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



Our current collaborative relationships may not
prove to be beneficial to us, and they may not be sustained. We also may not be able to enter into successful new strategic relationships in the future, which could have a material adverse effect on our business, operating results and financial
condition. We could lose sales opportunities if we fail to work effectively with these parties. Moreover, we expect that maintaining and enhancing these and other relationships will become a more meaningful part of our business strategy in the
future. However, many of our current partners are either actual or potential competitors with us. In addition, many of these third parties also work with competing software companies and we may not be able to maintain these existing relationships,
due to the fact that these relationships are informal or, if written, are terminable with little or no notice.



Failure to adequately protect our intellectual property rights could harm our competitive position



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



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



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



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



Our success and ability to compete
are also dependent on our ability to operate without infringing upon the proprietary rights of others. Third parties may claim that our current or future products infringe their intellectual property rights. Any such claim, with or without merit,
could have a significant effect on our business and financial results. For example, during 2003 and 2004 we incurred significant legal expenses defending intellectual property claims of Computer Associates International Inc., which were ultimately
settled during the first quarter of 2005 for a cash payment of $16.0 million and royalty payments to be made under a license arrangement. 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 them 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



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development costs if our software contains undetected errors or if we fail to meet our customers expectations. As a result of the foregoing, we could
experience:



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



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



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



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



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



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



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



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



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



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



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



Natural disasters or power
outages could disrupt our business



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



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



Our future success will depend on our ability to
continue to enhance our current products and to develop and introduce new products on a timely basis that keep pace with technological developments and satisfy increasingly sophisticated customer requirements. Rapid technological change, frequent
new product introductions and enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards characterize the market for our products and services. The introduction of products embodying new technologies and
the emergence of new industry standards can render our existing products obsolete and unmarketable. As a result of the complexities inherent in todays computing environments and the performance demanded by customers for embedded databases and
Web-based products, new products



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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.
| | - |  | --------------------------------------------------------------------------



Failure to attract and retain personnel may negatively impact our business



Our ability to manage the operation of our business and our future success depend on our ability to attract, motivate and
retain qualified employees. In addition, the success of our business is substantially dependent on the services of our Chief Executive Officer and other officers and key employees, many whom have recently joined our company. As our business grows,
we will need to hire additional administrative, sales and marketing, support, research and development and other personnel. 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. 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.



We have historically used stock-based compensation as an important tool to attract and retain employees, generally through
stock options granted under our stock incentive plans and the availability of discounted shares for purchase under our Employee Stock Purchase Plan. Our Employee Stock Purchase Plan was terminated at the end of July 2004. The number of options
available for grant under our stock incentive plans is limited and any future increase would require shareholder approval. There can be no guarantees that we will be able to obtain shareholder approval for required future increases in the number of
shares authorized under our stock incentive plans. In addition, when we change the way we account for stock options as a result of proposed changes in accounting rules, we may reduce our reliance on the use of stock options, which may negatively
affect our ability to recruit and retain qualified personnel.



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|Item 3: | Quantitative and Qualitative Disclosures About Market Risks
|------- | -----------------------------------------------------------



Foreign Exchange Risk



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



The foreign currencies to which
we currently have the most significant exposure are the Euro, the Canadian Dollar, the British Pound and the Australian Dollar. To date, we have not used derivative financial instruments to hedge our foreign exchange exposures, nor do we use such
instruments for speculative trading purposes. We regularly monitor the potential cost and benefits of hedging foreign exchange exposures with derivatives and there remains the possibility that our foreign exchange hedging practices could change
accordingly in time.



Interest Rate Risk



Our exposure to market interest-rate risk relates primarily to our
investment portfolio. We have not used derivative financial instruments to hedge the market risks of our investments. We place our investments with high-quality issuers and, by policy, limit the amount of credit exposure to any one issuer other than
the United States government and its agencies. Our investments in marketable securities consist primarily of investment-grade bonds and United States government and agency securities. Investments purchased with an original maturity of three months
or less are considered to be cash equivalents. We classify all of our investments as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of
shareholders equity.



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



|                                  |  |                     |         |                      |      |  
|--------------------------------- |  | ------------------- | ------- | -------------------- | ---- | -
|                                  |  | AmortizedBook Value |         | WeightedAverage Rate |     
|Investments maturing by March 31, |  |                     |         |                      |      |  
|2006 (a)                          |  | $                   | 56,626  |                      | 2.07 | %
|2007                              |  |                     | 79,999  |                      | 3.82 | %
|2008                              |  |                     | 19,410  |                      | 4.25 | %
|2009                              |  |                     | 10,639  |                      | 5.04 | %
|Thereafter                        |  |                     | 37,319  |                      | 4.92 | %
|                                  |  |                     |         |                      |      |  
|Total portfolio                   |  | $                   | 203,993 |                      | 3.64 | %
|                                  |  |                     |         |                      |      |  

---

|(a) | Includes cash and cash equivalents of $26.0 million.
|--- | ----------------------------------------------------



Historically we have been able to maintain a level of cash and cash equivalents such that we have generally been able to hold our investments to maturity.
Accordingly, changes in the market interest rate would not have a material effect on the fair value of such investments.



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|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 March 31, 2005, 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.



Changes in Internal Control Over Financial Reporting



In connection with the evaluation of our disclosure controls and procedures for the year ended December 31, 2004, our managements assessment identified a material weakness in our internal control over financial reporting with respect
to our calculations for the provision for income taxes. We have taken steps to remedy the deficiencies; primarily by engaging external tax advisors to assist in the preparation and review of our income tax calculations and by hiring additional
qualified staff. We believe these actions have strengthened our internal control over financial reporting and address the material weakness identified in our Annual Report on Form 10-K for the year ended December 31, 2004.



No other changes in our internal control over financial reporting have come
to our managements attention that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



Limitations on Effectiveness of Controls



Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent all errors and
all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues
and instances of fraud, if any, within Quest have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that internal controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.



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PART IIOTHER
INFORMATION



|Item 1: | Legal Proceedings
|------- | -----------------



During the first quarter of 2005, both of our material pending litigation matters were terminated. On March 21, 2005, we entered into a settlement agreement relating to the copyright infringement and trade secret misappropriation complaint
filed by Computer Associates International, Inc. (CA) in July 2002. In connection with the settlement, we paid CA $16.0 million in cash and agreed to pay royalties under a non-exclusive license agreement.



On January 18, 2005, the lead plaintiff in the consolidated amended
securities class action complaint voluntarily dismissed its complaint, with prejudice, without the payment of any consideration from Quest or its officers or directors. On February 4, 2005, the purported state derivative claim arising from the same
set of facts involved in the class action complaints was dismissed, without prejudice and without the payment of any consideration by Quest or its officers or directors.



We are a party to a variety of immaterial litigation proceedings and claims, either asserted or unasserted, which we
consider to be routine and incidental to our business. While the outcome of any of these matters cannot be predicted with certainty, we do not believe the outcome of any of these proceedings or claims will have a material adverse effect on our
consolidated financial position, results of operations or cash flows.



|Item 6: | Exhibits
|------- | --------



|              |  |                                                                                                                                                   
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Title                                                                                                                                     
|              | 
|10.1          |  | Settlement Agreement, executed on March 21, 2005, between Quest Software, Inc. and Computer Associates International, Inc.                        
|              | 
|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.



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SIGNATURES



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



|                   |  |  |  |                                               
|------------------ |  |  |  | ----------------------------------------------
|                   |  |  |  | QUEST SOFTWARE, INC.                          
|                   |  | 
|Date: May 10, 2005 |  |  |  | /s/    MICHAEL J.
LAMBERT                     
|                   |  |  |  | Michael J. Lambert                            
|                   |  |  |  | Senior Vice President, Chief Financial Officer
|                   |  | 
|                   |  |  |  | /s/    KEVIN E. BROOKS                        
|                   |  |  |  | Kevin E. Brooks                               
|                   |  |  |  | Vice President and Corporate Controller       



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