The following discussion of our financial condition and results of operations ("MD&A") should be read in conjunction with the condensed 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 condition 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 described under Item 1A - "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2008, 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

Our Company and Business Model

Quest Software, Inc., together with our subsidiaries ScriptLogic and Vizioncore, delivers innovative products that help IT organizations derive enhanced performance from their computing environment. Our product areas are Application Management, Database Management, Windows Management and Virtualization Management. Our products improve the performance, manageability and productivity of our customers' IT infrastructure.

Quarterly Update

As discussed in more detail throughout our MD&A, for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, we delivered the following financial performance:

• Total revenues decreased by $16.7 million, or 8.9%, to $170.8 million;

• Total expenses increased by $13.1 million, or 8.2%, to $172.8 million;

• Income from operations decreased by $29.8 million, or 107.2%, to a loss of $2.0 million;

• Other income (expense), net increased by $9.2 million, from a loss of $6.5 million in 2008 to a gain of $2.7 million in 2009;

• Diluted earnings per share decreased by $0.13, or 80.1%, to $0.03.

Our third quarter 2009 revenue performance continued to be affected by the generally weak macro-economic conditions. Total revenues within our EMEA and America sales regions were down approximately 17% and 6%, respectively, when compared to the comparable period of the prior year, while our Asia Pacific sales regions were up by approximately 9%.

Along product lines, total revenues from sales of all four of our product areas declined with the most notable declines coming from our Database Management product area. Our third quarter 2009 total revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 18%, or $2.9 million, of the overall decrease in total revenues.

Although total revenues continued to decline, we decreased our discretionary and headcount related expenses. This focus, combined with the benefit from foreign currency exchange rates resulted in an increase in our operating margin.

The increase in total expenses was due to a $29.4 million litigation loss provision recorded with our settlement of the shareholder class action relating to alleged stock option backdating. See Note 15 of our Notes to Condensed Consolidated Financial Statements for additional information. During the three months ended September 30, 2009, we experienced a significant decrease in personnel related costs, which include compensation, benefits and payroll related taxes compared against the same period in 2008. Our full-time employee headcount at the end of the third quarter of 2009 was 3,364, as compared to 3,477 at the end of the third quarter of 2008. Our full-time employee headcount in locations outside of the United States was 1,583 at the end of the third quarter of 2009 compared to 1,672 at the end of the third quarter of 2008. We continue to realize benefit from certain cost management initiatives we have undertaken since mid-2008 which include reduced headcount, travel costs, and other measures. Our third quarter 2009 total expenses were also impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009, which resulted in a lesser U.S. Dollar equivalent for several currencies as noted above. Since certain of our international expenses are denominated in these non-U.S. Dollar currencies, our total expenses in the third quarter of 2009 were reduced by approximately $6.4 million compared against the same period in 2008 as a result of the impact of foreign currency exchange rates.

Foreign Currency

While we are a U.S. Dollar functional company on a world-wide basis, we transact business and operate using multiple foreign currencies. As such, the value of our revenues, expenses, certain account balances and cash flows are exposed to fluctuations in foreign currencies against the value of the U.S. Dollar. For example, when the U.S. Dollar strengthens against several non-U.S. Dollar currencies as has recently occurred, our foreign revenues and thus our total revenues can be negatively impacted. Similarly, a stronger U.S. Dollar translates into lower expenses in those entities where we have operations and our personnel and occupancy expenses are denominated in non-U.S. Dollars. Thus our total expenses would be lower. Conversely, a weaker U.S. Dollar would have the opposite effect on total revenues and expenses all other things being equal. In certain geographic regions and within specific currencies, there are partial offsets between revenues and expenses or balance sheet positions that may reduce this exposure. In other instances, we can manage our operations to reduce foreign currency exposure or utilize derivative instruments to manage this exposure.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, asset valuations (including accounts receivable, goodwill and intangible assets), share-based compensation, income taxes and functional currencies for purpose of consolidation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Our estimates form the basis for making judgments about amounts and timing of revenue and expenses, the carrying values of assets, and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K for fiscal 2008 under Management's Discussion and Analysis of Financial Condition and Results of Operations. There have been no material changes to our critical accounting policies or estimates during the nine months ended September 30, 2009.

Recently Adopted Accounting Pronouncement

See Note 1 of our Notes to Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements.

Results of Operations

The following table sets forth selected condensed consolidated income statement
data for each of the periods indicated as a percentage of total revenues:



                                                       Three Months Ended          Nine Months Ended
                                                         September 30,               September 30,
                                                      2009           2008          2009          2008
Revenues:
Licenses                                                39.4 %         46.2 %        38.2 %       45.2 %
Services                                                60.6           53.8          61.8         54.8

Total revenues                                         100.0          100.0         100.0        100.0
Cost of revenues:
Licenses                                                 1.3            1.0           1.1          1.1
Services                                                 8.5            8.1           8.6          8.7
Amortization of purchased technology                     2.9            2.7           3.0          2.7

Total cost of revenues                                  12.7           11.8          12.7         12.5

Gross profit                                            87.3           88.2          87.3         87.5
Operating expenses:
Sales and marketing                                     37.9           41.0          39.3         44.0
Research and development                                20.3           19.8          21.6         21.5
General and administrative                              11.1           11.3          11.0         12.5
Amortization of other purchased intangible assets        1.9            1.3           2.0          1.4
In-process research and development                       -              -             -           0.2
Litigation loss provision                               17.2             -            5.9           -

Total operating expenses                                88.4           73.4          79.8         79.6

Income (loss) from operations                           (1.1 )         14.8           7.5          7.9
Other income (expense), net                              1.6           (3.5 )         0.7          0.8

Income before income tax provision (benefit)             0.5           11.3           8.2          8.7
Income tax provision (benefit)                          (1.3 )          2.1           1.6          1.3

Net income                                               1.8 %          9.2 %         6.6 %        7.4 %

Comparison of Three Months Ended September 30, 2009 and 2008

Revenues

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



                                  Three Months Ended
                                    September 30,           Increase/(Decrease)
                                   2009        2008       Dollars       Percentage
       Revenues:
       Licenses
       Americas                 $   44,009   $  54,473   $ (10,464 )         (19.2 )%
       Rest of World                23,314      32,227      (8,913 )         (27.7 )%

       Total license revenues       67,323      86,700     (19,377 )         (22.3 )%

       Services
       Americas                     69,049      66,375       2,674             4.0 %
       Rest of World                34,477      34,490         (13 )           0.0 %

       Total service revenues      103,526     100,865       2,661             2.6 %

       Total revenues           $  170,849   $ 187,565   $ (16,716 )          (8.9 )%

Licenses Revenues - The decrease in license revenues was due primarily to decreased sales of our Database Management products across all geographic regions and Windows Management products in our Europe, the Middle East and Africa ("EMEA") region. Our third quarter license revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 13% of the overall decrease in license revenues.

Services Revenues - Services revenues are derived from post-contract technical support services ("maintenance") and consulting and training services. The largest component of our services revenues is maintenance revenue. Maintenance revenues are generated from support and maintenance services relating to current year sales of new software products and from the renewal of existing maintenance agreements for software licenses sold in prior periods. The main driver of our growth in services revenues was maintenance renewals on our Windows Management products in the Americas. Also contributing to the growth in services revenues were maintenance renewals on our Virtualization Management products across all geographic regions. Maintenance revenues from our Database Management products decreased particularly in the EMEA region. Revenue from consulting and training services as a percentage of total service revenues was approximately 9.3% and 9.6% of total service revenues in the three months ended September 30, 2009 and 2008, respectively.

Maintenance revenues continue to contribute a larger percentage of our total revenues for three primary reasons: growth of our installed base of customers; acquisitions and their related maintenance contracts; and, multi-year pre-paid support programs. As our maintenance customer base grows, maintenance renewals have a larger influence on the maintenance revenue growth rate and the amount of new software license revenues has a diminishing effect. Therefore, the growth rate of total 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 maintenance revenue profile is the extent to which our customers renew their annual maintenance agreements, taking into account the number of products and licenses for which each customer renews, and the timing of the renewals by each such customer. If our maintenance renewals were to decline materially, our maintenance revenues, total revenues and cash flows would likely decline materially as well.

Over the past twelve months we have experienced declining growth in our maintenance revenues and expect this trend to continue through at least 2010. The three main reasons for this decline are: reduced sales of new software licenses during 2009; fewer acquisitions which resulted in less revenue contribution from acquired deferred maintenance revenues; and changes in foreign currency exchange rates.

Cost of Revenues

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



                                         Three Months Ended
                                           September 30,          Increase/(Decrease)
                                          2009         2008     Dollars       Percentage
Cost of revenues:
Licenses                               $     2,197   $  1,921   $    276            14.4 %
Services                                    14,607     15,167       (560 )          (3.7 )%
Amortization of purchased technology         4,983      5,026        (43 )          (0.9 )%

Total cost of revenues                 $    21,787   $ 22,114   $   (327 )          (1.5 )%

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 3.3% and 2.2% for the three months ended September 30, 2009 and 2008. The increase in cost of licenses, both in terms of absolute dollars and as a percentage of license revenues, was due to an impairment charge of $0.6 million taken on one of our prepaid royalty obligations. The royalty obligation was tied to a product that Quest discontinued selling in the third quarter of 2009. Excluding this charge cost of licenses was down $0.4 million, or 18% over the three months ended September 30, 2008 and cost of licenses as percentage of license revenues would have been 2.3%.

Cost of Services - Cost of services primarily consists of personnel, outside consultants, facilities and systems costs used in providing maintenance, consulting and training services. Cost of services does not include development costs related to bug fixes and upgrades which are classified in research and development and which are not separately determinable. Personnel related costs decreased by $0.5 million. Cost of services as a percentage of service revenues was 14.1% and 15.0% in the three months ended September 30, 2009 and 2008, respectively.

Amortization of Purchased Technology - Amortization of purchased technology includes amortization of the fair value of purchased technology associated with acquisitions. We expect amortization of purchased technology within the cost of revenues arising from acquisitions completed prior to September 30, 2009 to be approximately $4.5 million for the remaining three months of 2009.

Operating Expenses

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



                                              Three Months Ended
                                                 September 30,            Increase/(Decrease)
                                               2009         2008        Dollars        Percentage
Operating expenses:
Sales and marketing                         $   64,704    $  76,957    $ (12,253 )          (15.9 )%
Research and development                        34,721       37,169       (2,448 )           (6.6 )%
General and administrative                      18,971       21,120       (2,149 )          (10.2 )%
Amortization of other purchased
intangible assets                                3,258        2,418          840             34.7 %
Litigation loss provision                       29,400           -        29,400               -  %

Total operating expenses                    $  151,054    $ 137,664    $  13,390              9.7 %

Sales and Marketing - Sales and marketing expenses consist primarily of compensation and benefit costs for sales and marketing personnel, sales commissions, and costs of trade shows, travel and entertainment and various discretionary marketing programs. The decrease in sales and marketing expense, both in terms of absolute dollars and as a percentage of total revenues, was due primarily to a $9.4 million decrease in personnel related costs and a $0.7 million decrease in travel costs. The decrease in personnel related costs was due primarily to reductions in commissions, base salary and related payroll taxes, share-based compensation and bonuses. We also had a $0.5 million decrease in trade show costs and a $0.4 million decrease in advertising costs. The impact from foreign currency comprised approximately 25% of the overall decrease in sales and marketing expense.

Research and Development - Research and development expenses consist primarily of compensation and benefit costs for software developers who develop new products, bug fixes and upgrades to existing products and at times provide engineering support for maintenance services, software product managers, quality assurance and technical documentation personnel, and payments made to outside software development consultants in connection with our ongoing efforts to enhance our core technologies and develop additional products. The decrease in research and development expense during the three months ended September 30, 2009 over the comparable period in 2008 was due primarily to reduced expenditures related to certain post-acquisition contingent payment obligations that were tied to technology milestones. These obligations resulted in 2008 expenses of approximately $1.4 million, while in 2009 the charges were reduced to $0.2 million. Also, personnel and travel related costs decreased by $0.9 million. The impact from foreign currency comprised approximately 83% of the overall decrease in research and development expense.

General and Administrative - General and administrative expenses consist primarily of compensation and benefit costs for our executive, finance, legal, human resources, administrative and IS personnel, and professional fees for audit, tax and legal services. The decrease in general and administrative expense during the three months ended September 30, 2009 as compared to the same period in 2008 was due primarily to a decrease of $2.0 million in personnel related costs. Share-based compensation, which is included in personnel related costs, decreased by approximately $0.9 million in the 2009 period. Professional accounting, tax and legal fees increased by approximately $1.3 million due primarily to our ongoing litigation matters as described in Note 15 of our Notes to Condensed Consolidated Financial Statements, offset by a $1.0 million decrease in corporate insurance, recruiting fees and taxes. The impact from foreign currency comprised approximately 27% of the overall decrease in general and administrative expenses.

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. The increase in amortization of other purchased intangible assets was due primarily to a full quarter of amortization of intangible assets acquired in August and September of 2008, offset slightly by other intangible assets that were fully amortized prior to the three months ended September 30, 2009. We expect amortization of other purchased intangible assets within operating expenses arising from acquisitions completed prior to September 30, 2009 to be approximately $3.2 million for the remaining three months of 2009.

Litigation Loss Provision - Litigation loss provision of $29.4 million relates to our settlement of the shareholder class action for alleged stock option backdating 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. See Note 15 of our Notes to Condensed Consolidated Financial Statements for additional information.

Other Income (Expense), Net

Other income (expense), net increased to $2.7 million in income in the third quarter of 2009 from a $6.5 million expense in the third quarter of 2008. The largest impact to other income (expense), net was attributed to a foreign currency gain of $3.4 million compared to a loss of $9.5 million in the third quarter of 2009 and 2008, respectively. Our foreign currency gains or losses are predominantly attributable to translation gains or losses relative to the U.S. Dollar on the re-measurement of net monetary assets, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. Interest expense was $1.0 million and $0.1 million in the three months ended September 31, 2009 and 2008, respectively. The increase in interest expense is due to debt agreements entered into in 2009. See Note 7 of our Notes to Condensed Consolidated Financial Statements for additional information regarding our debt agreements. Interest income was $0.3 million and $2.8 million in the three months ended September 30, 2009 and 2008, respectively. The decrease in interest income was due primarily to lower average investment yields and average cash and investment balances.

Income Tax Provision (Benefit)

The income tax provision (benefit) was $(2.2) million for the three months ended September 30, 2009 compared to $3.9 million in the same period of 2008. The reduction is primarily related to the discrete tax impact of the settlement of the shareholder class action relating to alleged stock option backdating and the mix of pre-tax income between high and low tax jurisdictions. The effective income tax rate for the three months ended September 30, 2009 was (314.8)% compared to 18.6% in the comparable period of 2008.

Comparison of Nine Months Ended September 30, 2009 and 2008

Revenues

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



                                  Nine Months Ended
                                    September 30,          Increase/(Decrease)
                                  2009        2008       Dollars       Percentage
       Licenses
       Americas                 $ 121,022   $ 139,088   $ (18,066 )         (13.0 )%
       Rest of World               70,311     102,040     (31,729 )         (31.1 )%

       Total license revenues     191,333     241,128     (49,795 )         (20.7 )%

       Services
       Americas                   210,376     190,664      19,712            10.3 %
       Rest of World               98,995     101,986      (2,991 )          (2.9 )%

       Total service revenues     309,371     292,650      16,721             5.7 %

       Total revenues           $ 500,704   $ 533,778   $ (33,074 )          (6.2 )%

Licenses Revenues - The decrease in license revenues was due primarily to decreased sales of our Database Management products across all geographic regions and Windows Management products in our EMEA region. Our third quarter license revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 25% of the overall decrease in license revenues and approximately 40% of the decrease in our rest of world license revenues.

Services Revenues - The primary reason for growth in services revenues was maintenance renewals on our Windows Management products in the Americas. Also contributing to the growth in services revenues were maintenance renewals on our Virtualization Management products across all geographic regions. Maintenance revenues from our Database Management products decreased with most notable declines in the EMEA region. Revenue from consulting and training services as a percentage of total service revenues was approximately 8.8% and 10.3% of total . . .