Quest Software Reports Third Quarter 2009 Results: Financial News

Quest Software Reports Third Quarter 2009 Results
Tuesday November 3, 4:00 pm ET

ALISO VIEJO, Calif.--(BUSINESS WIRE)--Quest Software, Inc. (Nasdaq: QSFT - News) today reported financial results for the quarter ended September 30, 2009. Total revenues were $170.8 million, a 8.9% decrease compared to the prior year’s third quarter revenue of $187.6 million. Total revenues for the first nine months of 2009 were $500.7 million, a 6.2% decrease compared to $533.8 million for the same period in 2008. Operating margins decreased to (1.2)% and 7.6% for the three and nine months ended September 30, 2009, respectively, as compared to 14.8% and 7.8% for the three and nine months ended September 30, 2008, respectively, primarily due to the expense associated with the pending litigation settlement discussed below. On a non-GAAP basis operating margins were 24.3% and 21.4% for the three and nine months ended September 30, 2009, respectively.

Quest’s cash and investments at September 30, 2009, totaled $362.0 million, an increase of $31.7 million over the comparable balance at June 30, 2009. Quest generated cash flow from operations of $43.7 million in the third quarter of 2009, an increase of $8.6 million over the comparable period in 2008.

Quest also announced that it has reached an agreement in principle with the class representative to settle the shareholder class action relating to alleged option backdating that was filed in October 2006 in the U.S. District Court for the Central District of California against Quest and certain of its current or former officers and directors for a payment of $29.4 million. The parties are negotiating in good faith a stipulation of settlement which will be subject to court approval once finalized.

“The key theme for the third quarter was operating discipline,” said Doug Garn, president and CEO of Quest. “We delivered excellent margin improvement and operating cash flow this quarter. My primary focus is to ensure that Quest is continuing to execute well and that we are building a foundation for sustainable long-term growth.”

GAAP Results

Quest Software’s net income for the third quarter of 2009 was $2.9 million, or $0.03 per fully diluted share. This compares to net income of $17.3 million, or $0.16 per share on a fully diluted basis, for the third quarter of 2008. Operating margins decreased year-over-year from 14.8% to (1.2)% in the third quarter, resulting in an operating loss of $2.0 million which compares to income of $27.8 million for the corresponding period in 2008. Net income for the first nine months of 2009 was $33.3 million, or $0.35 per fully diluted share, versus net income of $38.9 million, or $0.36 per fully diluted share, for the comparable period in 2008.

Non-GAAP Results

On a non-GAAP basis, net income for the third quarter of 2009 was $31.2 million, or $0.34 per fully diluted share. This compares to non-GAAP net income of $26.8 million, or $0.25 per share on a fully diluted basis, for the third quarter of 2008. The non-GAAP operating margin was 24.3% in the third quarter of 2009, resulting in non-GAAP operating income of $41.6 million, compared to non-GAAP operating margin and operating income of 22.1% and $41.5 million, respectively, for the corresponding period in 2008. For the nine months ended September 30, 2009, non-GAAP net income was $80.8 million, or $0.86 per fully diluted share. This compares to non-GAAP net income of $66.7 million, or $0.63 per fully diluted share, for the nine months ended September 30, 2008. The non-GAAP operating margin was 21.4% in the first nine months of 2009, resulting in non-GAAP operating income of $107.4 million, compared to non-GAAP operating margin of 15.6% and non-GAAP operating income of $83.5 million in the comparable period of 2008.

Non-GAAP results exclude the after-tax effects of amortization of intangible assets acquired with business combinations, share-based compensation expenses, acquisition related costs, expenses and litigation loss provision associated with the pending settlement of the shareholder class action arising from Quest’s stock option investigation. A reconciliation of GAAP to non-GAAP financial results is included with this press release.

Quest’s management prepares and uses non-GAAP financial measures in the presentation of the Company’s results to provide a consistent understanding of its historical operating performance and comparisons with peer companies. Management believes that non-GAAP reporting provides a more meaningful representation of the Company’s on-going economic performance and therefore uses non-GAAP reporting internally to evaluate and manage the Company’s operations. Management believes excluding charges such as those described above from its GAAP results facilitates investors’ understanding of the Company’s ongoing business operating results. These non-GAAP financial measures also facilitate comparisons to the operating results of the Company’s competitors and provide investors with greater transparency with respect to the supplemental information used by management in its operational and financial decision making.

Third Quarter 2009 Conference Call Information

Quest Software will host a conference call today, Tuesday, November 3, 2009, at 2:00 p.m. Pacific Time, to discuss its results. A simultaneous webcast of the conference call will be available on Quest’s website in the Investor Relations section at www.quest.com/investor_relations/. A webcast replay will be available on the same website through November 3, 2010. An audio replay of the conference call will also be available through November 10, 2009 by dialing (888) 203-1112 (from the U.S. or Canada) or 719-457-0820 (outside the U.S. and Canada), using confirmation code: 8652894.

About Quest Software, Inc.

Now more than ever, organizations need to work smart and improve efficiency. Quest Software creates and supports smart systems management products – helping our customers solve everyday IT challenges faster and easier. Visit www.quest.com for more information.

Quest and Quest Software are registered trademarks of Quest Software, Inc. The Quest Software logo and all other Quest Software product or service names and slogans are registered trademarks or trademarks of Quest Software, Inc. All other trademarks and registered trademarks are property of their respective owners.

Forward-Looking Statements

This release and the matters to be discussed on the conference call may include predictions, estimates and other information that might be considered forward-looking statements, including statements relating to expectations of future revenue and operating margin performance and other operating prospects and statements relating to the settlement of the shareholder class action. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from those anticipated as a result of various factors, including: risks associated with finalizing and obtaining court approval of a stipulation of settlement of the shareholder class action, the impact of adverse changes in general economic conditions on Quest’s relationships with customers, strategic partners and vendors; reductions or delays in information technology spending; variations in demand or the size and timing of customer orders; competitive conditions in Quest’s various product areas; rapid technological change; risks associated with the development and market acceptance of new products and product strategies; disruptions caused by acquisitions of companies and/or technologies; fluctuating currency exchange rates and risks associated with international operations; the need to attract and retain qualified employees; and other risks inherent in software businesses. For a discussion of these and other related risks, please refer to Quest’s recent SEC filings, including the Annual Report on Form 10-K for the year ended December 31, 2008, which are available on the SEC's website at www.sec.gov. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date thereof. Quest undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof.

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share data)

(Unaudited)

Three Months Ended Nine Months Ended

September 30, September 30,

2009 2008 2009 2008

Revenues:

Licenses $ 67,323 $ 86,700 $ 191,333 $ 241,128

Services 103,526 100,865 309,371 292,650

Total revenues 170,849 187,565 500,704 533,778

Cost of revenues:

Licenses 2,197 1,921 5,740 6,110

Services 14,607 15,167 42,867 46,571

Amortization of purchased technology 4,983 5,026 14,924 14,619

Total cost of revenues 21,787 22,114 63,531 67,300

Gross profit 149,062 165,451 437,173 466,478

Operating expenses:

Sales and marketing 64,704 76,957 196,732 234,604

Research and development 34,721 37,169 107,928 114,687

General and administrative 18,971 21,120 55,170 66,811

Amortization of other purchased intangible assets 3,258 2,418 9,925 7,730

In-process research and development - - - 955

Litigation loss provision 29,400 - 29,400 -

Total operating expenses 151,054 137,664 399,155 424,787

Income (loss) from operations (1,992 ) 27,787 38,018 41,691

Other income (expense), net 2,703 (6,526 ) 3,338 4,385

Income before income tax provision (benefit) 711 21,261 41,356 46,076

Income tax provision (benefit) (2,238 ) 3,944 8,019 7,204

Net income $ 2,949 $ 17,317 $ 33,337 $ 38,872

Net income per share:

Basic $ 0.03 $ 0.16 $ 0.36 $ 0.37

Diluted $ 0.03 $ 0.16 $ 0.35 $ 0.36

Weighted average shares:

Basic 88,968 105,434 92,540 104,334

Diluted 91,846 107,450 94,483 106,697

Reconciliation of Non-GAAP Financial Measures to Comparable U.S. GAAP Measures (Unaudited)

The Company has provided a reconciliation of each non-GAAP financial measure used in this earnings release and related conference call and webcast to the most directly comparable GAAP financial measure. These measures differ from GAAP in that they exclude amortization of intangible assets acquired with business combinations, share-based compensation expenses, acquisition related costs, expenses, including indemnification advances and settlement amounts, associated with litigation arising from Quest’s stock option investigation and the estimated tax effect related to each of these items. The Company’s basis for these adjustments is described below.

Quest Software’s management prepares and uses non-GAAP financial measures in the presentation of the Company’s results to provide a consistent understanding of its historical operating performance and comparisons with peer companies. Management believes that non-GAAP reporting provides a more meaningful representation of the Company’s on-going economic performance and therefore uses non-GAAP reporting internally to evaluate and manage the Company’s operations. Management believes excluding charges such as those described above from its GAAP results facilitates investors’ understanding of the Company’s ongoing business operating results. These non-GAAP financial measures also facilitate comparisons to the operating results of the Company’s competitors and provide investors with greater transparency with respect to the supplemental information used by management in its operational and financial decision making.

Management excludes the expenses described above when evaluating the Company’s operating performance and believes that the resulting non-GAAP measures are useful to investors and financial analysts in assessing the Company’s operating performance due to the following factors:

The Company does not acquire businesses on a predictable cycle. The Company, therefore, believes that the presentation of non-GAAP measures that adjust for the impact of intangible asset amortization that are related to business combinations, provides investors and financial analysts with a consistent basis for comparison across accounting periods and, therefore, is useful to help investors and financial analysts better understand the Company's operating results and underlying operational trends.
Amortization costs are fixed at the time of an acquisition, then amortized over a period of several years after the acquisition and generally cannot be changed or influenced by management after the acquisition.
Although share-based compensation is an important aspect of the compensation of the Company’s employees and executives, share-based compensation expense and its related tax impact are excluded as such charges are generally fixed at the time of grant and amortized over a period of several years and cannot be changed nor influenced by management after the grant.
Share-based compensation is not an expense that typically requires or will require cash settlement by the Company.
Acquisition related costs include expenses incurred for outside legal fees and costs and other professional fees.
Ongoing litigation arising from Quest’s stock option investigation includes expenses incurred for outside legal fees and costs, consulting services and other professional fees, indemnification expenses for current and former directors and officers, and settlement amounts. Because these expenses are non-recurring and unique to the stock option investigation, the Company believes they are not indicative of future operating results and that investors benefit from an understanding of Quest’s operating results without giving effect to them.
The estimated income tax effects on the above items adjust the provision for income taxes to reflect the effect of the non-GAAP adjustments on non-GAAP operating income.

These non-GAAP financial measures are not prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and may differ from the non-GAAP information used by other companies. There are significant limitations associated with the use of non-GAAP financial measures. The additional non-GAAP financial information presented here should be considered in conjunction with, and not as a substitute for or superior to, the financial information presented in accordance with GAAP (such as net income and earnings per share) and should not be considered measures of the Company’s liquidity. Furthermore, the Company in the future may exclude amortization related to new business combinations from financial measures that it releases, and the Company expects to continue to incur share-based compensation expenses.

QUEST SOFTWARE, INC.

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

TO MOST DIRECTLY COMPARABLE GAAP FINANCIAL MEASURES

(In thousands, except per share data)

(Unaudited)

Three Months Ended September 30, Nine Months Ended September 30,

2009 2008 2009 2008

GAAP total cost of revenues $ 21,787 $ 22,114 $ 63,531 $ 67,300

Amortization of purchased technology (4,983 ) (5,026 ) (14,924 ) (14,619 )

Share-based compensation expense (185 ) (151 ) (521 ) (688 )

Non-GAAP total cost of revenues $ 16,619 $ 16,937 $ 48,086 $ 51,993

GAAP gross profit $ 149,062 $ 165,451 $ 437,173 $ 466,478

Amortization of purchased technology 4,983 5,026 14,924 14,619

Share-based compensation expense 185 151 521 688

Non-GAAP gross profit $ 154,230 $ 170,628 $ 452,618 $ 481,785

GAAP income (loss) from operations $ (1,992 ) $ 27,787 $ 38,018 $ 41,691

Amortization of purchased technology 4,983 5,026 14,924 14,619

Amortization of other purchased intangible assets 3,258 2,418 9,925 7,730

Share-based compensation expense 4,034 5,234 11,365 15,222

Acquisition related costs 16 - 120 -

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
1,893 1,033 3,611 3,235

In-process research and development - - - 955

Litigation loss provision 29,400 - 29,400 -

Non-GAAP income from operations $ 41,592 $ 41,498 $ 107,363 $ 83,452

GAAP net income $ 2,949 $ 17,317 $ 33,337 $ 38,872

Amortization of purchased technology 4,983 5,026 14,924 14,619

Amortization of other purchased intangible assets 3,258 2,418 9,925 7,730

Share-based compensation expense 4,034 5,234 11,365 15,222

Acquisition related costs 16 - 120 -

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
1,893 1,033 3,611 3,235

In-process research and development - - - 955

Litigation loss provision 29,400 - 29,400 -

Tax effect of these adjustments (15,349 ) (4,198 ) (21,860 ) (13,938 )

Non-GAAP net income $ 31,184 $ 26,830 $ 80,822 $ 66,695

GAAP net income per basic share $ 0.03 $ 0.16 $ 0.36 $ 0.37

Amortization of purchased technology 0.05 0.05 0.16 0.14

Amortization of other purchased intangible assets 0.04 0.02 0.11 0.07

Share-based compensation expense 0.05 0.05 0.12 0.15

Acquisition related costs - - - -

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
0.02 0.01 0.04 0.03

In-process research and development - - - 0.01

Litigation loss provision 0.33 - 0.32 -

Tax effect of these adjustments (0.17 ) (0.04 ) (0.24 ) (0.13 )

Non-GAAP net income per basic share $ 0.35 $ 0.25 $ 0.87 $ 0.64

Shares used in basic per share amounts 88,968 105,434 92,540 104,334

GAAP net income per fully diluted share $ 0.03 $ 0.16 $ 0.35 $ 0.36

Amortization of purchased technology 0.05 0.05 0.16 0.14

Amortization of other purchased intangible assets 0.04 0.02 0.11 0.07

Share-based compensation expense 0.05 0.05 0.12 0.15

Acquisition related costs - - - -

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
0.02 0.01 0.04 0.03

In-process research and development - - - 0.01

Litigation loss provision 0.32 - 0.31 -

Tax effect of these adjustments (0.17 ) (0.04 ) (0.23 ) (0.13 )

Non-GAAP net income per fully diluted share $ 0.34 $ 0.25 $ 0.86 $ 0.63

Shares used in fully diluted per share amounts 91,846 107,450 94,483 106,697

QUEST SOFTWARE, INC.

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

TO MOST DIRECTLY COMPARABLE GAAP FINANCIAL MEASURES (Continued)

(In thousands, except per share data)

(Unaudited)

Three Months Ended September 30, 2009

Sales and Marketing Research and Development General and Administrative Amortization of Other Purchased Intangible Assets Litigation Loss Provision Total Operating Expenses

GAAP operating expenses $ 64,704 $ 34,721 $ 18,971 $ 3,258 $ 29,400 $ 151,054

Amortization of other purchased intangible assets - - - (3,258) - (3,258)

Share-based compensation expense (1,047) (1,473) (1,329) - - (3,849)

Acquisition related costs - - (16) - - (16)

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
- - (1,893) - - (1,893)

Litigation loss provision - - - - (29,400) (29,400)

Non-GAAP operating expenses $ 63,657 $ 33,248 $ 15,733 $ - $ - $ 112,638

Three Months Ended September 30, 2008

Sales and Marketing Research and Development General and Administrative Amortization of Other Purchased Intangible Assets In-process Research and Development Total Operating Expenses

GAAP operating expenses $ 76,957 $ 37,169 $ 21,120 $ 2,418 $ - $ 137,664

Amortization of other purchased intangible assets - - - (2,418) - (2,418)

Share-based compensation expense (1,588) (1,283) (2,212) - - (5,083)

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
- - (1,033) - - (1,033)

In-process research and development - - - - - -

Non-GAAP operating expenses $ 75,369 $ 35,886 $ 17,875 $ - $ - $ 129,130

Nine Months Ended September 30, 2009

Sales and Marketing Research and Development General and Administrative Amortization of Other Purchased Intangible Assets Litigation Loss Provision Total Operating Expenses

GAAP operating expenses $ 196,732 $ 107,928 $ 55,170 $ 9,925 $ 29,400 $ 399,155

Amortization of other purchased intangible assets - - - (9,925) - (9,925)

Share-based compensation expense (3,768) (4,074) (3,002) - - (10,844)

Acquisition related costs - - (120) - (120)

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
- - (3,611) - - (3,611)

Litigation loss provision - - - - (29,400) (29,400)

Non-GAAP operating expenses $ 192,964 $ 103,854 $ 48,437 $ - $ - $ 345,255

Nine Months Ended September 30, 2008

Sales and Marketing Research and Development General and Administrative Amortization of Other Purchased Intangible Assets In-process Research and Development Total Operating Expenses

GAAP operating expenses $ 234,604 $ 114,687 $ 66,811 $ 7,730 $ 955 $ 424,787

Amortization of other purchased intangible assets - - - (7,730) - (7,730)

Share-based compensation expense (5,537) (4,505) (4,492) - - (14,534)

Professional fees related to our ongoing legal and indemnification expense relating to our previous restatement
- - (3,235) - - (3,235)

In-process research and development - - - - (955) (955)

Non-GAAP operating expenses $ 229,067 $ 110,182 $ 59,084 $ - $ - $ 398,333

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

ASSETS

September 30, December 31,

2009 2008

Current assets:

Cash and cash equivalents $ 303,465 $ 215,895

Restricted cash 900 2,425

Short-term investments 58,549 632

Accounts receivable, net 124,545 153,892

Prepaid expenses and other current assets 19,116 17,362

Deferred income taxes 30,776 18,460

Total current assets 537,351 408,666

Property and equipment, net 71,587 77,394

Long-term investments - 41,410

Intangible assets, net 79,918 104,567

Goodwill 659,195 655,777

Deferred income taxes 23,313 28,026

Other assets 26,274 29,819

Total assets $ 1,397,638 $ 1,345,659

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable $ 4,579 $ 3,798

Accrued compensation 40,325 45,079

Other accrued expenses 27,414 39,760

Litigation loss provision 29,400 -

Current portion of loans payable 34,213 -

Current portion of income taxes payable 6,090 167

Current portion of deferred revenue 258,189 272,626

Total current liabilities 400,210 361,430

Long-term liabilities:

Long-term portion of deferred revenue 76,790 66,086

Long-term portion of income taxes payable 38,697 40,846

Long-term portion of loans payable 33,428 -

Other long-term liabilities 7,228 3,545

Total long-term liabilities 156,143 110,477

Stockholders’ equity 841,285 873,752

Total liabilities and stockholders’ equity $ 1,397,638 $ 1,345,659

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

Three Months Ended Nine Months Ended

September 30, September 30,

2009 2008 2009 2008

Cash flows from operating activities:

Net income $ 2,949 $ 17,317 $ 33,337 $ 38,872

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization 11,950 11,650 36,596 34,859

Compensation expense associated with share-based payments 4,035 5,139 11,366 14,306

Deferred income taxes (2,608 ) (2,539 ) 1,184 (421 )

Unrealized gains on long-term investments, net of loss from put options (81 ) - (483 ) -

Excess tax benefit related to share-based compensation (347 ) (190 ) (639 ) (3,328 )

Provision for bad debts 59 342 120 756

In-process research and development - - - 955

Litigation loss provision 29,400 - 29,400 -

Other non-cash adjustments, net (121 ) - (61 ) -

Changes in operating assets and liabilities, net of effects of acquisitions:

Accounts receivable (11,936 ) (10,291 ) 32,128 37,663

Prepaid expenses and other current assets (844 ) 1,207 (34 ) 1,178

Other assets 2,337 544 1,687 (348 )

Accounts payable 1,310 (2,640 ) (1,988 ) (1,557 )

Accrued compensation (652 ) (2,748 ) (7,691 ) (7,840 )

Other accrued expenses (652 ) 1,944 (10,110 ) (3,738 )

Income taxes payable (1,973 ) 6,831 (8,280 ) (7,657 )

Deferred revenue 10,436 8,539 (3,733 ) 10,671

Other liabilities 481 13 3,508 33

   Net cash provided by operating activities
43,743 35,118 116,307 114,404

Cash flows from investing activities:

Purchases of property and equipment (4,337 ) (2,651 ) (8,277 ) (8,181 )

Cash paid for acquisitions, net of cash acquired (96 ) (82,554 ) (96 ) (135,226 )

Change in restricted cash 26 (2,370 ) 1,690 46,554

Purchases of cost method investments - - (3,000 ) (3,160 )

Purchases of investment securities (11,993 ) (4 ) (11,993 ) (52,003 )

Sales and maturities of investment securities 749 258 1,289 39,322

   Net cash used in investing activities
(15,651 ) (87,321 ) (20,387 ) (112,694 )

Cash flows from financing activities:

Proceeds from loans payable 67,897 - 67,897 -

Repayment of loans payable (725 ) - (725 ) -

Repurchase of common stock (97,203 ) - (101,119 ) -

Repayment of capital lease obligations (67 ) (98 ) (193 ) (205 )

Cash paid for line of credit fees - - (1,979 ) -

Proceeds from the exercise of stock options 22,937 1,820 27,600 38,644

Excess tax benefit related to share-based compensation 347 190 639 3,328

Proceeds received from certain executive officers as part of our restatement remedial actions - 200 - 200

   Net cash provided by (used in) financing activities
(6,814 ) 2,112 (7,880 ) 41,967

Effect of exchange rate changes on cash and cash equivalents (853 ) 3,074 (470 ) 1,246

Net increase (decrease) in cash and cash equivalents 20,425 (47,017 ) 87,570 44,923

Cash and cash equivalents, beginning of period 283,040 327,508 215,895 235,568

Cash and cash equivalents, end of period $ 303,465 $ 280,491 $ 303,465 $ 280,491