Regulation

Quest’s Quest Finds More Backdating Errors

Database-management software company, expecting a $143-million charge, details some of the issues it has encountered.
Stephen TaubSeptember 19, 2007

Quest Software Inc., in discussing an expected $143 million pre-tax charge to correct errors in past accounting for stock options, said it had found additional mistakes in its historical financial statements that need correcting.

The Aliso Viejo, Calif.-based developer of database management software had said in January that it expected to take a charge of about $150 million as the result of an internal investigation, which had found backdating of stock-option grants to employees from July 1998 to May 2002. This week’s press release, narrowing the amount of the expected pre-tax charge to $143 million, from 1999 through March 31, 2006, said that $137.7 million of the total relates to expenses in revising stock-option grant dates. Other adjustments, it said, arise from stock-option modifications and repricing of stock option grants, among other things.

The additional errors included, for example, the incorrect or inconsistent application of revenue recognition rules and policies for certain transactions. Quest also determined that it should have recorded intangible asset impairment charges relating to certain acquired software products when they were discontinued rather than continuing ratable amortization over that asset’s remaining estimated useful life.

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In addition, it identified certain errors affecting the amount of other income or expense recorded in prior periods. Most of the errors involved timing adjustments that eventually offset each other within the periods covered by the restatement or over the terms of the underlying customer contracts.

The new adjustments it found reflected certain errors that were not previously recorded because, in each case, the underlying mistakes were not considered by management to be material to our consolidated financial statements, Quest said. The other accounting adjustments will not materially impact the company’s current or prior years’ liquidity or cash flow or the company’s total cumulative revenue or operating income, it said.

As a result of the numerous additional accounting adjustments, it said, total revenue for each annual period covered by the restatement is expected to be adjusted by less than 1.2 percent of the amount previously reported for that period. In addition, total revenue is expected to slightly decrease in 2000, 2001, and 2005, and to slightly increase in 2002, 2003, and 2004.

However, the company warned that the impact on net income and earnings per share cannot be determined now because the combined effects of the stock-option adjustments and other accounting corrections to reported provisions for income tax is still being calculated.

Quest, which has not filed quarterly reports for the second and third quarters of 2006 quarters or the first and second quarters, and has not filed its 2006 annual report, noted that it was unable to meet Nasdaq’s Sept. 17 deadline for filing all delinquent reports in compliance with the exchange’s requirements. On Sept. 14, Nasdaq gave the company until Nov. 14 to file all delinquent reports.

“There can be no assurance that Nasdaq will provide the company with any additional time, if necessary, or that the company’s common stock will remain listed on the Nasdaq Global Select Market,” Quest said.

In its January press release, Quest had maintained that both current and former senior management of the company “bear varying degrees of responsibility for deficiencies” in its stock option administration and related internal controls. The company stressed, however, that the special committee conducting the investigation found no fraud or intentional misconduct by any current or former employees, officers, or directors, and did not recommend any further changes in the company’s executive officers.

Last November, senior vice president for corporate development M. Brinkley Morse, who served as chief financial officer from January 2001 to April 2005, resignedafter declining to be interviewed by the special committee about the company’s stock options practices.