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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________

FORM 10-Q

__________________



x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2018



o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission file number 001-35662

__________________

QUALYS, INC.

(Exact name of registrant as specified in its charter)

__________________



Delaware		77-0534145
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

919 E. Hillsdale Boulevard, 4th Floor, Foster City, California 94404

(Address of principal executive offices, including zip code)

(650) 801-6100

(Registrant’s telephone number, including area code)

__________________

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	x	Accelerated filer	o
Non-accelerated filer	o	(Do not check if a smaller reporting company)
		Smaller reporting company	o
		Emerging growth company	o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares of the Registrant's common stock outstanding as of April 30, 2018 was 38,978,887.

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Qualys, Inc.

TABLE OF CONTENTS



		Page
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2018 and 2017	4
	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017	5
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017	6
	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	39
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 3.	Defaults upon Senior Securities	62
Item 4.	Mine Safety Disclosures	62
Item 5.	Other Information	62
Item 6.	Exhibits	63
	Signatures	64

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PART I. FINANCIAL INFORMATION


Item 1.	Financial Statements

Qualys, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share data)



	March 31, 2018			December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	93,174		$	86,591
Short-term investments	235,353			201,823
Accounts receivable, net of allowance of $802 and $816 as of March 31, 2018 and December 31, 2017, respectively	49,874			64,412
Prepaid expenses and other current assets	15,488			16,524
Total current assets	393,889			369,350
Long-term investments	65,363			67,224
Property and equipment, net	60,696			58,557
Deferred tax assets, net	24,085			25,066
Intangible assets, net	11,769			12,401
Goodwill	1,549			1,549
Restricted cash	1,200			1,200
Other noncurrent assets	7,061			2,178
Total assets	$	565,612		$	537,525
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,310		$	1,144
Accrued liabilities	22,181			21,444
Deferred revenues, current	147,656			143,186
Total current liabilities	171,147			165,774
Deferred revenues, noncurrent	14,995			17,136
Other noncurrent liabilities	13,151			11,071
Total liabilities	199,293			193,981
Commitments and contingencies (Note 6)
Stockholders’ equity:
Preferred stock, $0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at March 31, 2018 and December 31, 2017	—			—
Common stock, $0.001 par value; 1,000,000,000 shares authorized; 38,957,692 and 38,598,117 shares issued and outstanding at March 31, 2018 and December 31, 2017	39			39
Additional paid-in capital	316,694			304,155
Accumulated other comprehensive loss	(965		)	(574		)
Retained earnings	50,551			39,924
Total stockholders’ equity	366,319			343,544
Total liabilities and stockholders’ equity	$	565,612		$	537,525

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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Qualys, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)



	Three Months Ended
	March 31,
	2018			2017
Revenues	$	64,878		$	53,121
Cost of revenues	15,901			12,294
Gross profit	48,977			40,827
Operating expenses:
Research and development	12,553			9,823
Sales and marketing	16,233			16,014
General and administrative	11,785			7,334
Total operating expenses	40,571			33,171
Income from operations	8,406			7,656
Other income (expense), net:
Interest expense	(38		)	(2		)
Interest income	1,090			481
Other income (expense), net	193			(26		)
Total other income (expense), net	1,245			453
Income before income taxes	9,651			8,109
Provision for (benefit from) income taxes	509			(13,821		)
Net income	$	9,142		$	21,930
Net income per share:
Basic	$	0.24		$	0.60
Diluted	$	0.22		$	0.56
Weighted average shares used in computing net income per share:
Basic	38,789			36,493
Diluted	41,934			38,845

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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Qualys, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands)



	Three Months Ended
	March 31,
	2018			2017
Net income	$	9,142		$	21,930
Available-for-sale investments:
Change in net unrealized loss on investments, net of tax	(407		)	(62		)
Less: reclassification adjustment for net realized gain (loss) included in net income, net of tax	16			(8		)
Other comprehensive loss, net of tax	(391		)	(70		)
Comprehensive income	$	8,751		$	21,860

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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Qualys, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



	Three Months Ended
	March 31,
	2018			2017
Cash flows from operating activities:
Net income	$	9,142		$	21,930
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense	7,043			4,820
Bad debt expense	—			10
Loss on disposal of property and equipment	7			2
Stock-based compensation	8,891			4,332
Amortization of premiums and accretion of discounts on investments	36			426
Deferred income taxes	140			(22,559		)
Excess tax benefits included in deferred tax assets	—			8,368
Changes in operating assets and liabilities:
Accounts receivable	14,538			5,375
Prepaid expenses and other assets	(2,341		)	981
Accounts payable	(302		)	255
Accrued liabilities	4,577			463
Deferred revenues	2,330			8,012
Other non-current liabilities	(1,072		)	10
Net cash provided by operating activities	42,989			32,425
Cash flows from investing activities:
Purchases of investments	(72,176		)	(60,201		)
Sales and maturities of investments	40,080			63,738
Purchases of property and equipment	(5,985		)	(4,543		)
Net cash used in investing activities	(38,081		)	(1,006		)
Cash flows from financing activities:
Proceeds from exercise of stock options	7,933			5,602
Payments for taxes related to net share settlement of equity awards	(4,030		)	(14,107		)
Principal payments under capital lease obligations	(747		)	—
Repurchase of common stock	(1,481		)	—
Net cash provided by (used in) financing activities	1,675			(8,505		)
Net increase in cash, cash equivalents and restricted cash	6,583			22,914
Cash, cash equivalents and restricted cash at beginning of period	87,791			87,937
Cash, cash equivalents and restricted cash at end of period	$	94,374		$	110,851

Supplemental disclosures of cash flow information:
Cash paid for interest expense	$	73		$	—
Cash paid for income taxes, net of refunds	$	437		$	380
Non-cash investing and financing activities
Purchases of property and equipment recorded in accounts payable and accrued liabilities	$	1,127		$	3,027
Purchase of assets under capital lease	$	2,755		$	—

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


NOTE 1.	The Company and Summary of Significant Accounting Policies

Description of Business

Qualys, Inc. (the “Company”, "we", "us", "our") was incorporated in the state of Delaware on December 30, 1999. The Company is headquartered in Foster City, California and has majority-owned subsidiaries throughout the world. The Company is a pioneer and leading provider of cloud-based security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations. The Company’s cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Organizations can use the Company’s integrated suite of solutions delivered on its Qualys cloud platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and condensed footnotes have been prepared by the Company in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information as well as the instructions to Form 10-Q and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet as of December 31, 2017, included herein, was derived from the audited financial statements as of that date but does not include all disclosures, including notes required by U.S. GAAP. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the three month period ended March 31, 2018 are not necessarily indicative of the results of operations expected for the entire year ending December 31, 2018 or for any other future annual or interim period. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 23, 2018.

Except for the changes below, the Company has consistently applied the accounting policies, described in its Annual Report on Form 10-K for the year ended December 31, 2017, to all periods presented in the condensed consolidated financial statements.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The Company adopted Accounting Standards Codification ("ASC") 606 Revenue from Contracts with Customers with a date of initial application of January 1, 2018. The Company adopted ASC 606 using the modified retrospective method and recognized the cumulative effect as an adjustment to the opening balance of equity at January 1, 2018. Therefore, the comparative information from the prior period has not been adjusted and continues to be reported under ASC 605. The impact of adopting ASC 606 was related to the deferral of sales commission costs for new business and when customers increase their renewal orders (“upsells”). The Company previously expensed sales commissions as incurred. Under ASC 606, sales commissions cost related to new business and upsells are recorded as an asset. The Company expenses the commission cost as a selling expense on a straight-line basis over a period of five years. Five years represents the estimated life of the customer relationship taking into account factors such as peer estimates of technology lives and customer lives as well as the Company's own historical data. Applying the practical expedient in ASC 340-40-25-4, the Company expenses commissions related to contract renewals with a renewal contract term of one year or less. The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets, and other noncurrent assets, respectively, in its condensed consolidated balance sheets.

On January 1, 2018, the Company recorded an increase to retained earnings of $2.7 million which was the net cumulative impact associated with the capitalization of sales commissions. Additionally, the Company recorded a corresponding commission asset balance of $3.5 million and a related deferred tax liability of $0.8 million. There was no impact to the Company's revenues as a result of adopting ASC 606. Without the adoption of ASC 606, commission expenses would have been $0.5 million higher in the three months ended March 31, 2018. See Note 4, “Revenue from Contracts with Customers”, for additional information regarding the impact on the Company's condensed consolidated financial statements.

Recently Adopted Accounting Pronouncements

In January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which will impact certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The ASU will impact the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The Company adopted this ASU in its first quarter of 2018. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force), to provide guidance on the presentation of certain cash receipts and cash payments in the statement of cash flows in order to reduce diversity in existing practice. The Company adopted this ASU in its first quarter of 2018. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The update provides guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. The Company adopted this ASU retrospectively in its first quarter of 2018. The Company reclassified restricted cash of $1.2 million each for the three months ended March 31, 2018 and 2017, in the condensed consolidated statements of cash flows.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. The Company adopted this ASU prospectively in its first quarter of 2018. The Company will apply the provisions of the update to future acquisitions.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Recently Issued Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize all leases, including operating leases, on the balance sheet as a lease asset or lease liability, unless the lease is a short-term lease. ASU 2016-02 also requires additional disclosures regarding leasing arrangements. ASU 2016-02 is effective for the Company beginning in the first quarter of fiscal 2019 and early adoption is permitted. Pursuant to the leasing criteria, most of the Company's leased space and equipment leases will be required to be accounted for as capitalized assets on the balance sheet with offsetting financing obligations. In the statement of operations, what was formerly rent expense will be bifurcated into depreciation and interest expense. The Company is currently evaluating the impact and expects the ASU will have a material impact on its condensed consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (Topic 350). This standard eliminates Step 2 from the goodwill impairment test, instead requiring an entity to recognize a goodwill impairment charge for the amount by which the goodwill carrying amount exceeds the reporting unit’s fair value. This ASU is effective for interim and annual goodwill impairment tests in fiscal years beginning after December 15, 2019 with early adoption permitted. This ASU must be applied on a prospective basis. The adoption of this ASU is not expected to have a material impact on the Company's condensed consolidated financial statements.

In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU eliminates the stranded tax effects in other comprehensive income resulting from the Tax Cuts and Jobs Act (the “TCJA”). Because the amendments only relate to the reclassification of the income tax effects of the TCJA, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. ASU 2018-02 is effective for us beginning in the first quarter of fiscal 2019 and early adoption is permitted. The Company is currently evaluating the impact of this ASU on its condensed consolidated financial statements.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 2.	Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For certain of the Company’s financial instruments, including certain cash equivalents, accounts receivable, accounts payable, and other current liabilities, the carrying amounts approximate their fair values due to the relatively short maturity of these balances.

The Company measures and reports certain cash equivalents, investments and derivative foreign currency forward contracts at fair value in accordance with the provisions of the authoritative accounting guidance that addresses fair value measurements. This guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities.

Level 2—Valuations based on other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Valuations based on inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.

The Company's financial instruments consist of assets and liabilities measured using Level 1 and 2 inputs. Level 1 assets include a highly liquid money market fund, which is valued using unadjusted quoted prices that are available in an active market for an identical asset. Level 2 assets include fixed-income U.S. government agency securities, commercial paper, corporate bonds, asset-backed securities and derivative financial instruments consisting of foreign currency forward contracts. The securities, bonds and commercial paper are valued using prices from independent pricing services based on quoted prices in active markets for similar instruments or on industry models using data inputs such as interest rates and prices that can be directly observed or corroborated in active markets. The foreign currency forward contracts are valued using observable inputs, such as quotations on forward foreign exchange points and foreign interest rates.

The Company's cash and cash equivalents, short-term investments, and long-term investments consist of the following:



	March 31, 2018
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
	(in thousands)
Cash and cash equivalents:
Cash	$	78,685	$	—	$	—		$	78,685
Money market funds	208		—		—			208
Commercial paper	14,284		—		(3		)	14,281
Total	93,177		—		(3		)	93,174
Short-term investments:
Commercial paper	11,866		—		(7		)	11,859
Corporate bonds	39,296		1		(139		)	39,158
U.S. government agencies	184,613		—		(277		)	184,336
Total	235,775		1		(423		)	235,353
Long-term investments:
Asset-backed securities	14,665		—		(32		)	14,633
U.S. government agencies	19,091		2		(73		)	19,020
Corporate bonds	32,097		1		(388		)	31,710
Total	65,853		3		(493		)	65,363
Total	$	394,805	$	4	$	(919	)	$	393,890

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	December 31, 2017
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
	(in thousands)
Cash and cash equivalents:
Cash	$	86,500	$	—	$	—		$	86,500
Money market funds	91		—		—			91
Total	86,591		—		—			86,591
Short-term investments:
Commercial paper	12,623		—		(3		)	12,620
Corporate bonds	38,425		1		(64		)	38,362
U.S. government agencies	151,058		—		(217		)	150,841
Total	202,106		1		(284		)	201,823
Long-term investments:
Asset-backed securities	4,998		—		(12		)	4,986
U.S. government agencies	24,269		—		(54		)	24,215
Corporate bonds	38,198		—		(175		)	38,023
Total	67,465		—		(241		)	67,224
Total	$	356,162	$	1	$	(525	)	$	355,638

The following table shows the changes to accumulated other comprehensive loss for the three months ended March 31, 2018 (in thousands):



	Unrealized (Loss) Gain, net on Investments
Balance at December 31, 2017	$	(574	)
Change in net unrealized loss on investments, net of tax	(407		)
Amounts reclassified for net realized gain included in net income, net of tax	16
Other comprehensive loss, net of tax	(391		)
Balance at March 31, 2018	$	(965	)

The following table sets forth by level within the fair value hierarchy the fair value of the Company's available-for-sale securities measured on a recurring basis, excluding cash and money market funds:



	March 31, 2018
	Level 1		Level 2		Level 3		Fair Value
	(in thousands)
Commercial paper	$	—	$	26,140	$	—	$	26,140
U.S. government agencies	—		203,356		—		203,356
Corporate bonds	—		70,868		—		70,868
Asset-backed securities	—		14,633		—		14,633
Total	$	—	$	314,997	$	—	$	314,997

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	December 31, 2017
	Level 1		Level 2		Level 3		Fair Value
	(in thousands)
Commercial paper	$	—	$	12,620	$	—	$	12,620
U.S. government agencies	—		175,056		—		175,056
Corporate bonds	—		76,385		—		76,385
Asset-backed securities	—		4,986		—		4,986
Total	$	—	$	269,047	$	—	$	269,047

There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy, as determined at the end of each reporting period.

The following summarizes the fair value of securities classified as available-for-sale by contractual, or effective, maturity:



	March 31, 2018
	Mature within One Year		After One Year through Two Years		Over Two Years		Fair Value
	(in thousands)
Commercial paper	$	26,140	$	—	$	—	$	26,140
U.S. government agencies	184,336		16,859		2,161		203,356
Corporate bonds	39,158		26,833		4,877		70,868
Asset-backed securities	6,162		8,471		—		14,633
Total	$	255,796	$	52,163	$	7,038	$	314,997

Derivative Financial Instruments

Derivative financial instruments are utilized by the Company to reduce foreign currency exchange risks. The Company uses foreign currency forward contracts to mitigate the impact of foreign currency fluctuations of certain non-U.S. dollar denominated asset positions, primarily cash and accounts receivable. These contracts are recorded within prepaid expenses and other current assets or accrued liabilities in the condensed consolidated balance sheets. Gains and losses resulting from currency exchange rate movements on these forward contracts are recognized in other income (expense) in the accompanying condensed consolidated statements of operations in the period in which the exchange rates change and offset the foreign currency gains and losses on the underlying exposure being hedged. The Company does not enter into derivative financial instruments for trading or speculative purposes.

At March 31, 2018, the Company had two outstanding forward contracts with notional amounts of 10.0 million Euros and 6.0 million British Pounds, respectively, which expired on April 30, 2018. At December 31, 2017, the Company had two outstanding forward contracts with notional amounts of 7.0 million Euros and 4.8 million British Pounds, respectively, which expired on January 31, 2018. These forward contracts were entered into at the end of each month, and thus the fair value of these contracts was $0 at March 31, 2018 and December 31, 2017. These derivatives did not meet the criteria to be designated as hedges. These instruments were valued using Level 2 inputs.

The following summarizes the gains (losses) recognized in Other income (expense), net on the condensed consolidated statement of operations, from forward contracts and other foreign currency transactions:

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	Three Months Ended
	March 31,
	2018			2017
	(in thousands)
Net loss from forward contracts	$	(578	)	$	(257	)
Other foreign currency transactions gain	810			260
Total foreign exchange gain, net	$	232		$	3


NOTE 3.	Property and Equipment, Net

Property and equipment, net, which includes assets under capital lease, consists of the following:



	March 31,			December 31,
	2018			2017
	(in thousands)
Computer equipment	$	80,215		$	77,883
Computer software	21,176			20,447
Furniture, fixtures and equipment	5,408			5,075
Assets under capital lease	3,503			—
Scanner appliances	15,010			14,325
Leasehold improvements	16,348			16,067
Total property and equipment	141,660			133,797
Less: accumulated depreciation and amortization	(80,964		)	(75,240		)
Property and equipment, net	$	60,696		$	58,557

Physical scanner appliances and other computer equipment that are or will be subject to leases by customers have a net carrying value of $6.9 million and $6.8 million at March 31, 2018 and December 31, 2017, respectively, including assets that have not been placed in service of $1.0 million and $0.9 million, respectively. Depreciation and amortization expense relating to property and equipment, including capitalized leases, was $6.4 million and $4.7 million for the three months ended March 31, 2018 and 2017, respectively. Accumulated depreciation under capital leases was $0.2 million at March 31, 2018.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 4.	Revenue from Contracts with Customers

In May 2014, the FASB issued a new standard related to revenue recognition. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method applied to those contracts which were not completed as of that date. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. The Company implemented internal controls and key system functionality to enable the preparation of financial information on adoption. The impact of the standard relates to the Company's accounting for sales commissions. The Company previously expensed sales commissions as incurred. Under ASC 606, the Company is required to capitalize certain contract acquisition costs consisting primarily of commissions paid related to new business and upsells. Applying the practical expedient in ASC 340-40-25-4, the Company expenses commissions related to contract renewals with a renewal contract term of one year or less.

As a result of the adoption, the Company recorded an increase to retained earnings of $2.7 million as of January 1, 2018 which was the net cumulative impact associated with the capitalization of sales commissions. Additionally, the Company recorded a corresponding commission asset balance of $3.5 million and a related deferred tax liability of $0.8 million as of January 1, 2018. There was no impact to the Company's revenues as a result of adopting ASC 606.

Incremental direct costs of obtaining a contract, which consist of sales commissions primarily for new business and upsells, are deferred and amortized over the estimated life of the customer relationship if renewals are expected and the renewal commission is not commensurate with the initial commission. The Company expenses the commission cost as a selling expense on a straight-line basis over a period of five years. The Company classifies deferred commissions as current or noncurrent based on the timing of when it expects to recognize the expense. The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets and other noncurrent assets, respectively, in its condensed consolidated balance sheets. The Company has elected the practical expedient for sales commissions related to renewals and expenses these as and when incurred because the amortization period would have been one year or less.

Commission asset balances are as follows (in thousands):



	March 31, 2018		January 1, 2018
Commission asset, current	$	845	$	704
Commission asset, noncurrent	$	3,142	$	2,819

For the three months ended March 31, 2018, the Company recognized $0.2 million of commission expense from amortization of its commission assets. There was no impairment loss related to capitalized costs. No contract costs were capitalized in the three months ended March 31, 2017.

Contract liabilities (deferred revenue) balances are as follows (in thousands):

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	March 31, 2018
	ASC 606		Operating Leases		Total
Deferred revenue, current	$	135,144	$	12,512	$	147,656
Deferred revenue, noncurrent	13,603		1,392		14,995
Total	$	148,747	$	13,904	$	162,651

	January 1, 2018
	ASC 606		Operating Leases		Total
Deferred revenue, current	$	130,579	$	12,607	$	143,186
Deferred revenue, noncurrent	15,419		1,717		17,136
Total	$	145,998	$	14,324	$	160,322

The Company records deferred revenue when cash payments are received or due in advance of its performance. The increase in the Company's deferred revenue balances for the three months ended March 31, 2018 is primarily driven by cash payments received or due in advance of satisfying the Company's performance obligations, offset by $55.6 million of revenue recognized in the three months ended March 31, 2018, which was included in the deferred revenue balance as of December 31, 2017.

The Company's performance obligations are typically satisfied ratably over the subscription term as its cloud-based offerings are delivered to customers electronically and over time. In addition, the Company recognizes revenues for certain limited scan arrangements on an as-used basis. The Company recognizes revenue related to the professional services as they are performed.

The Company allocates the transaction price to all separate performance obligations, including transactions that are comprised of lease revenue, in proportion to the standalone selling prices ("SSP") of the goods or services underlying each of those performance obligations at contract inception. If a SSP is not directly observable, the Company determines the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and volume purchased in determining the SSP. The Company's transaction prices are typically a fixed amount for a specific period of time and majority of contracts are twelve months with certain customers signing longer term deals. In general, the Company does not offer rights of return, performance bonuses, customer loyalty programs, payments via non-cash methods, refunds, volume rebates, incentive payments, penalties, price concessions or payments or discounts contingent on future events. Consideration is fixed at the time of the contract, and governed by the price list to which that particular customer is subject. The Company’s customer and partner-specific pricing is negotiated and agreed upon via individual customer contracts. In some of its contracts, the Company incorporates tiered pricing based on the number of IP addresses the customer can scan. As customers are required to purchase larger quantities to qualify for the lower-priced tiers, the Company does not grant its customers any material rights. When customers increase their purchased quantities, the Company accounts for the additional purchased quantities and related price change prospectively as the pricing does not impact subscription services previously provided. Physical equipment (scanners and private cloud platforms) are accounted for as operating leases and revenue is recognized over the subscription term.

Accounts receivable, net, consists of the following (in thousands):



	March 31, 2018			January 1, 2018
ASC 606 receivables	$	46,234		$	60,984
Operating lease receivables	4,442			4,244
Less: allowance for doubtful accounts	(802		)	(816		)
Total accounts receivable, net	$	49,874		$	64,412

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The Company's payment terms vary by the type and location of its customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, the Company requires payment before the products or services are delivered to the customer.

The following table sets forth the expected revenue from all remaining performance obligations as of March 31, 2018 (in thousands):



	ASC 606 Revenues		Operating Lease Revenues		Total Revenues
2018 (remaining nine months)	$	8,290	$	261	$	8,551
2019	14,724		1,068		15,792
2020	7,980		387		8,367
2021	2,498		43		2,541
2022	1,775		20		1,795
2023 and thereafter	1,213		4		1,217
Total	$	36,480	$	1,783	$	38,263

Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Remaining performance obligations represents the transaction price of firm orders for which service has not been performed and excludes unexercised renewals.

From time to time, the Company enters into contracts with customers that extend beyond one year with certain of its customers electing to pay for more than one year of services upon contract execution. For any discounts associated with these multiple year contracts, the Company does not consider these contracts to contain a financing component as its customers typically initiate the longer terms, and the Company's reasoning for entering into the longer terms is not based on financing.

Revenues by sales channel are as follows:



	Three Months Ended March 31, 2018
	ASC 606 Revenues		Operating Lease Revenues		Total Revenues
Direct	$	34,968	$	3,742	$	38,710
Partner	24,235		1,933		26,168
Total	$	59,203	$	5,675	$	64,878

	Three Months Ended March 31, 2017
	ASC 606 Revenues		Operating Lease Revenues		Total Revenues
Direct	$	27,620	$	3,394	$	31,014
Partner	20,259		1,848		22,107
Total	$	47,879	$	5,242	$	53,121

The Company utilizes partners to enable and accelerate the adoption of its cloud platform by increasing its distribution capabilities and market awareness of its cloud platform as wells as by targeting geographic regions outside the reach of its direct sales force. The Company's channel partners maintain relationships with their customers throughout the territories in which they operate and provide their customers with services and third-party solutions to help meet those customers’ evolving security and compliance requirements. As such, these partners may offer the Company's IT security and compliance solutions in conjunction with one or more of their own products or services and act as a conduit through which the Company can connect with these prospective customers to offer its solutions. For sales involving a channel partner, the channel partner engages with the prospective customer directly and involves

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

the Company's sales team as needed to assist in developing and closing an order. When a channel partner secures a sale, the Company sells the associated subscription to the channel partner who in turn resells the subscription to the customer. Sales to channel partners are made at a discount and revenues are recorded at this discounted price over the subscription terms. The Company does not have any influence or specific knowledge of its partners' selling terms with their customers. See Note 11, "Segment Information and Information about Geographic Area" for disaggregation of revenue by geographic area.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 5.	Goodwill and Intangible Assets, Net

Intangible assets consist primarily of developed technology and patent licenses acquired in business combinations. Acquired intangibles are amortized on a straight-line basis over the respective estimated useful lives of the assets.

The carrying values of intangible assets are as follows (in thousands, except for years):



					March 31, 2018
	Weighted Average Life (Years)	Weighted Remaining Average Life (Years)	Cost		Accumulated Amortization			Net Book Value
Developed technology	5	4.5	$	12,156	$	(1,068	)	$	11,088
Patent licenses	14	6.4	1,388		(747		)	641
Total intangibles subject to amortization			$	13,544	$	(1,815	)	11,729
Intangible assets not subject to amortization								40
Total intangible assets, net								$	11,769

					December 31, 2017
	Weighted Average Life (Years)	Weighted Remaining Average Life (Years)	Cost		Accumulated Amortization			Net Book Value
Developed technology	5	4.8	$	14,067	$	(2,371	)	$	11,696
Patent Licenses	14	6.7	1,388		(723		)	665
Total intangibles subject to amortization			$	15,455	$	(3,094	)	12,361
Intangible assets not subject to amortization								40
Total intangible assets, net								$	12,401

Intangible asset amortization expense was $0.6 million and $0.1 million for the three months ended March 31, 2018 and 2017, respectively.

As of March 31, 2018, the Company expects amortization expense in future periods to be as follows (in thousands):



2018 (remaining nine months)	$	1,899
2019	2,531
2020	2,531
2021	2,531
2022	2,071
2023 and thereafter	166
Total expected future amortization expense	$	11,729

Goodwill, which is not subject to amortization, totaled $1.5 million as of each of March 31, 2018 and December 31, 2017.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 6.	Commitments and Contingencies

Leases

The Company leases certain computer equipment and its corporate office and data center facilities under non-cancelable operating leases for varying periods through 2028. In January 2018, the Company entered into a $3.5 million financing arrangement for data center storage equipment, accounted for as a capital lease, with an implied interest rate of 5%.

The following are the minimum annual lease payments due under these leases at March 31, 2018 (in thousands):



	Operating Leases		Capital Leases
	(in thousands)
2018 (remaining nine months)	$	6,912	$	940
2019	5,786		1,770
2020	5,407		130
2021	4,662		54
2022	4,140		—
2023 and thereafter	22,000		—
Total minimum lease payments	$	48,907	2,894
Less: amount representing interest			(139		)
Present value of minimum payments			2,755
Less: current portion			(1,289		)
Capital lease obligations, noncurrent			$	1,466

Rent expense was $2.2 million and $1.9 million for the three months ended March 31, 2018 and 2017, respectively. Although certain of the operating lease agreements provide for rent free periods or escalating rent payments over the terms of the leases, rent expense under these agreements is recognized on a straight-line basis over the term of the lease, starting when the Company takes possession of the property from the landlord. As of March 31, 2018 and December 31, 2017, the Company had accrued $10.2 million and $9.5 million, respectively, of deferred rent related to these agreements, which is reflected in accrued liabilities and other non-current liabilities in the accompanying condensed consolidated balance sheets.

On October 14, 2016, the Company entered into a lease agreement for its new headquarters office facility. The lease payments commenced on May 1, 2018 and the lease has a ten-year term through April 30, 2028. The total commitment of $38.6 million is payable monthly with escalating rental payments throughout the lease term. In connection with this lease, the Company has provided the landlord with a $1.2 million standby letter of credit to secure the Company’s obligations through the end of the lease term, which was classified as restricted cash in the accompanying condensed consolidated balance sheets.

Indemnifications

The Company from time to time enters into certain types of contracts that contingently require it to indemnify various parties against claims from third parties. These contracts primarily relate to (i) the Company's by-laws, under which it must indemnify directors and executive officers, and may indemnify other officers and employees, for liabilities arising out of their relationship, (ii) contracts under which the Company must indemnify directors and certain officers for liabilities arising out of their relationship, and (iii) contracts under which the Company may be required to indemnify customers or resellers from certain liabilities arising from potential infringement of intellectual property rights, as well as potential damages caused by limited product defects. To date, the Company has not incurred and has not recorded any liability in connection with such indemnifications.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors.

Contingencies

The Company regularly licenses technology from various third party licensors. From time to time, the Company is audited by its licensors for compliance with the terms of the license agreements. During the quarter ended March 31, 2018, the Company commenced discussions with one of its vendors with respect to compliance with the terms of the license agreement. The Company intends to cooperate with the licensor while defending itself vigorously to bring the review process to a resolution. The Company accrues for losses on individual matters that are both probable and reasonably estimable. Estimates are based on currently available information and assumptions. Significant judgment is required in both the determination of probability and the determination of whether a matter is reasonably estimable. The Company’s estimates may change and actual expenses could differ in the future as additional information becomes available or as the Company reaches agreements with its vendors. Management currently estimates that it has sufficiently accrued for licensing agreement matters and that the range of loss (in excess of amounts accrued) is not significant.


NOTE 7.	Stock-based Compensation

Equity Incentive Plans

2012 Equity Incentive Plan

Under the 2012 Equity Incentive Plan (the "2012 Plan"), the Company is authorized to grant to eligible participants incentive stock options (“ISOs”), non-statutory stock options (“NSOs”), stock appreciation rights ("SARs"), restricted stock awards ("RSAs"), restricted stock units ("RSUs"), performance units and performance shares equivalent to up to 11,791,139 shares of common stock. Options may be granted with an exercise price that is at least equal to the fair market value of the Company's stock at the date of grant and are exercisable when vested. As of March 31, 2018, 4,186,394 shares were available for grant under the 2012 Plan.

2000 Equity Incentive Plan

Under the 2000 Equity Incentive Plan (the "2000 Plan"), the Company was authorized to grant to eligible participants either ISOs or NSOs. The 2000 Plan was terminated in connection with the closing of the Company's initial public offering, and accordingly, no shares are currently available for grant under the 2000 Plan. The 2000 Plan continues to govern outstanding awards granted thereunder.

Stock-based compensation

The following table shows a summary of the stock-based compensation expense included in the condensed consolidated statements of operations for the three months ended March 31, 2018 and 2017:



	Three Months Ended
	March 31,
	2018		2017
	(in thousands)
Cost of revenues	$	654	$	501
Research and development	1,841		1,221
Sales and marketing	1,401		1,084
General and administrative	4,995		1,526
Total stock-based compensation	$	8,891	$	4,332

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

As of March 31, 2018, the Company had $14.5 million of total unrecognized employee compensation cost related to unvested options that it expects to recognize over a weighted-average period of 2.2 years, and $41.8 million of unrecognized employee compensation cost related to unvested awards that it expects to recognize over a weighted-average period of 2.9 years. Compensation cost is recognized on a straight-line basis over the service period. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Stock Option Plan Activity

A summary of the Company’s stock option activity is as follows:



	Outstanding Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
						(in thousands)
Balance as of December 31, 2017	4,495,891		$	25.29	6.6	$	153,129
Granted	61,850		$	59.95
Exercised	(286,597	)	$	27.68
Canceled	(83,608	)	$	38.62
Balance as of March 31, 2018	4,187,536		$	25.37	6.5	$	198,395,610
Vested and expected to vest - March 31, 2018	3,969,350		$	24.76	6.4	$	190,509,569
Exercisable - March 31, 2018	2,895,704		$	21.89	5.7	$	147,268,457

Restricted Stock

A summary of the Company’s RSU and RSA activity is as follows:



	Outstanding RSUs and RSAs		Weighted Average Grant Date Fair Value Per Share

Balance as of December 31, 2017	1,410,588		$	40.34
Granted	92,232		$	59.95
Vested	(158,561	)	$	37.96
Canceled	(54,410	)	$	39.92
Balance as of March 31, 2018	1,289,849		$	42.05
Outstanding and expected to vest - March 31, 2018	1,124,366		$	41.45

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 8.	Net Income Per Share

The computations for basic and diluted net income per share are as follows:



	Three Months Ended
	March 31,
	2018		2017
	(in thousands, except per share data)
Numerator:
Net income	$	9,142	$	21,930
Denominator:
Weighted-average shares used in computing net income per share:
Basic	38,789		36,493
Effect of potentially dilutive securities:
Common stock options	2,503		2,176
Restricted stock units	642		176
Diluted	41,934		38,845
Net income per share:
Basic	$	0.24	$	0.60
Diluted	$	0.22	$	0.56

Potentially dilutive securities not included in the calculation of diluted net income per share because doing so would be antidilutive are as follows:



	Three Months Ended
	March 31,
	2018	2017
	(in thousands)
Common stock options	109	1,432
Restricted stock units	—	53
	109	1,485


NOTE 9.	Stockholder's Equity

Share Repurchase Program

On February 5, 2018, the Company's Board of Directors authorized a $100.0 million share repurchase program, which was announced on February 12, 2018. The stock repurchase authorization does not have an expiration date. The Company's stock repurchases may be effected from time to time through open market purchases. Repurchased shares are retired and reclassified as authorized and unissued shares of common stock. On retirement of the repurchased shares, common stock is reduced by an amount equal to the number of shares being retired multiplied by the par value. The excess of the cost of treasury stock that is retired over its par value is first allocated as a reduction to additional paid-in capital based on the initial public offering price of the stock, with the remaining excess to retained earnings.

During the three months ended March 31, 2018, the Company repurchased 21,288 shares for approximately $1.5 million. All share repurchases were made using cash resources. As of March 31, 2018, approximately $98.5 million remained available for share repurchases pursuant to the Company's share repurchase program.

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)


NOTE 10.	Income Taxes

Our tax provision for income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period.

Our quarterly tax provision, and estimate of our annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income (or loss), the mix of jurisdictions to which such income relates, changes in how we do business, and tax law developments. Our estimated effective tax rate for the year differs from the U.S. statutory rate of 21% primarily due to non-deductible stock-based compensation expense, state taxes, foreign income subject to different tax rates than the U.S., and the benefit of U.S. federal income tax credits.

The Company recorded an income tax provision of $0.5 million and income tax benefit of $13.8 million for the three months ended March 31, 2018 and 2017, respectively. The Company's effective income tax rate was approximately 5.3% and (170.4)% for the three months ended March 31, 2018 and 2017, respectively.

On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law. The new legislation contains significant tax provisions that affect the Company, including a one-time repatriation tax on accumulated foreign earnings, a reduction of the corporate income tax rate from 35% to 21%, which was effective January 1, 2018, and a change from a worldwide tax system to a modified territorial system.

In accordance with Staff Accounting Bulletin No. 118 ("SAB 118"), the effects of the 2017 Tax Act may be adjusted within a one-year measurement period from the enactment date of the 2017 Tax Act for items that were previously reported as provisional estimates, or where a provisional estimate could not be made. The income tax provision for the three months ended March 31, 2018, does not reflect any adjustment to the provisional estimates recorded in the year ended December 31, 2017. The Company will continue to assess forthcoming guidance and accounting interpretations on the effects of the 2017 Tax Act and expects to complete its analysis within the measurement period in accordance with the SEC guidance. Such analysis includes both the implications of the newly introduced provisions for Global Intangible Low Tax Income and the detailed analysis of historical foreign earnings and potential correlative adjustments to verify the one-time transition tax does not apply.

As of March 31, 2018, the Company had unrecognized tax benefits of $5.3 million, of which $3.0 million, if recognized, would favorably impact the Company's effective tax rate. As of December 31, 2017, the Company had unrecognized tax benefits of $5.1 million, of which $2.8 million, if recognized, would favorably impact the Company's effective tax rate. The Company does not anticipate a material change in its unrecognized tax benefits in the next 12 months.


NOTE 11.	Segment Information and Information about Geographic Area

The Company operates in one segment. The Company’s chief operating decision maker is the Chairman, President and Chief Executive Officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis. All of the Company’s principal operations and decision-making functions are located in the United States.

Revenues by geographic area, based on the location of the customer, are as follows (in thousands):

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Qualys, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



	Three Months Ended March 31, 2018
	ASC 606 Revenues		Operating Lease Revenues		Total Revenues
United States	$	40,308	$	4,006	$	44,314
Foreign	18,895		1,669		20,564
Total	$	59,203	$	5,675	$	64,878

	Three Months Ended March 31, 2017
	ASC 606 Revenues		Operating Lease Revenues		Total Revenues
United States	$	33,882	$	3,579	$	37,461
Foreign	13,997		1,663		15,660
Total	$	47,879	$	5,242	$	53,121

Property and equipment, net, by geographic area, are as follows:



	March 31,		December 31,
	2018		2017
	(in thousands)
United States	$	51,573	$	50,785
Foreign	9,123		7,772
Total property and equipment, net	$	60,696	$	58,557


NOTE 12.	Subsequent Event

On April 1, 2018, the Company announced that it had acquired certain assets of Singapore-based 1Mobility, expanding the Company’s domain expertise in passive scanning and deep packet inspection as well as accelerating its entrance into the mitigation and response segment, natively from the Qualys cloud platform. Total purchase consideration related to the acquisition was $4.0 million in cash, of which $0.6 million is payable in the future subject to terms and conditions of the purchase agreement. The acquisition will be accounted for as a business combination.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with (1) our condensed consolidated financial statements (unaudited) and the related notes included elsewhere in this report, and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the Securities and Exchange Commission, or SEC, on February 23, 2018.

In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, it is possible to identify forward-looking statements because they contain words such as “anticipates,” “believes,” “contemplates,” “continue,” “could,” “estimates,” “expects,” “future,” “intends,” “likely,” “may,” “plans,” “potential,” “predicts,” “projects,” “seek,” “should,” “target,” or “will,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:


•	our financial performance, including our revenues, costs, expenditures, growth rates, operating expenses and ability to generate positive cash flow to fund our operations and sustain profitability;


•	anticipated technology trends, such as the use of cloud solutions;


•	our ability to adapt to changing market conditions;


•	economic and financial conditions, including volatility in foreign exchange rates;


•	our ability to diversify our sources of revenues, including selling additional solutions to our existing customers and our ability to pursue new customers;


•	the effects of increased competition in our market;


•	our ability to innovate and enhance our cloud solutions and platform and introduce new solutions;


•	our ability to effectively manage our growth;


•	our anticipated investments in sales and marketing, our infrastructure, new solutions, and research and development, and acquisitions;


•	maintaining and expanding our relationships with channel partners;


•	our ability to maintain, protect and enhance our brand and intellectual property;


•	costs associated with defending intellectual property infringement and other claims;


•	our ability to attract and retain qualified employees and key personnel, including sales and marketing personnel;


•	our ability to successfully enter new markets and manage our international expansion;


•	our expectations, assumptions and conclusions related to our provision for income taxes, our deferred tax assets and our effective tax rate; and


•	other factors discussed in this Quarterly Report on Form 10-Q in the sections titled “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations.”

We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. The results, events and circumstances reflected in these forward-looking statements are subject to risks, uncertainties, assumptions, and other factors including those described in Part II, Item 1A (Risk Factors) of this Quarterly Report and those discussed in other documents we file with the SEC. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements used herein. We cannot provide assurance that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.

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Overview

We are a pioneer and leading provider of a cloud-based platform delivering security and compliance solutions that enable organizations to identify security risks to their information technology (IT) infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations. Our cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Our integrated suite of security and compliance solutions delivered on our Qualys cloud platform enables our customers to identify their IT assets, collect and analyze large amounts of IT security data, discover and prioritize vulnerabilities, recommend remediation actions and verify the implementation of such actions. Organizations use our integrated suite of solutions delivered on our Qualys cloud platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures as our solution offers a single platform for information security, application security, endpoint, developer security and cloud teams.

We were founded and incorporated in December 1999 with a vision of transforming the way organizations secure and protect their IT infrastructure and applications and initially launched our first cloud solution, Vulnerability Management (VM), in 2000. As VM gained acceptance, we introduced new solutions to help customers manage increasing IT security and compliance requirements. Today, the suite of solutions offered on our cloud platform, which we refer to as the Qualys Cloud Apps, includes: Asset Inventory (AI), CMDB Sync (SYN), VM, Continuous Monitoring (CM), Cloud Agent Platform (CAP), Threat Protection (TP), Security Configuration Assessment (SCA), Indication of Compromise (IOC), Policy Compliance (PC), PCI Compliance (PCI), Security Assessment Questionnaire (SAQ), File Integrity Monitoring (FIM), Web Application Scanning (WAS) and Web Application Firewall (WAF). Our VM solutions (including VM, AI, SYN, CM, TP, Cloud Agent for VM, allocated scanner revenue and Qualys Private Cloud Platform) have provided a substantial majority of our revenues to date, representing 74% of our revenues for the three months ended March 31, 2018.

We provide our solutions through a software-as-a-service model, primarily with renewable annual subscriptions. These subscriptions require customers to pay a fee in order to access our cloud solutions. We invoice our customers for the entire subscription amount at the start of the subscription term, and the invoiced amounts are treated as deferred revenues and are recognized ratably over the term of each subscription. We continue to experience significant revenue growth from existing customers as they renew and purchase additional subscriptions.

Our revenues increased to $64.9 million in the three months ended March 31, 2018 from $53.1 million for the comparable period in 2017, representing an increase of $11.8 million or 22%.

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Key Metric

In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metric set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.



	Three Months Ended
	March 31,
	2018			2017
	(in thousands, except percentages)
Adjusted EBITDA	$	24,618		$	16,808
Percentage of revenues	38		%	32		%

Adjusted EBITDA

We monitor Adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that Adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude in Adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that Adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. We calculate Adjusted EBITDA as net income before (1) other (income) expense, net, which includes interest income, interest expense and other income and expense, (2) provision for (benefit from) income taxes, (3) depreciation and amortization of property and equipment, (4) amortization of intangible assets, (5) stock-based compensation, (6) non-recurring expenses and (7) acquisition-related expenses that do not reflect ongoing costs of operating the business.

The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for the three months ended March 31, 2018 and 2017:



	Three Months Ended
	March 31,
	2018			2017
	(in thousands)
Net income	$	9,142		$	21,930
Depreciation and amortization of property and equipment	6,410			4,727
Amortization of intangible assets	633			93
Interest expense	38			2
Provision for (benefit from) income taxes	509			(13,821		)
EBITDA	16,732			12,931
Stock-based compensation	8,891			4,332
Other (income) expense, net	(1,283		)	(455		)
Acquisition-related expense⁽¹⁾	278			—
Adjusted EBITDA	$	24,618		$	16,808

(1) Adjusted EBITDA for the three months ended March 31, 2018 excludes approximately $0.3 million of compensation expense from the acquisition of NetWatcher.

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Limitations of Adjusted EBITDA

Adjusted EBITDA, a non-GAAP financial measure, has limitations as an analytical tool, and should not be considered in isolation from or as a substitute for the measures presented in accordance with U.S. GAAP. Some of these limitations are:


•	Adjusted EBITDA does not reflect certain cash and non-cash charges that are recurring;


•	Adjusted EBITDA does not reflect income tax payments that reduce cash available to us;


•	Adjusted EBITDA excludes depreciation and amortization of property and equipment and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future; and


•	Other companies, including companies in our industry, may calculate Adjusted EBITDA differently or not at all, which reduces its usefulness as a comparative measure.

Because of these limitations, Adjusted EBITDA should be considered alongside other financial performance measures, including revenues, net income, cash flows from operating activities and our financial results presented in accordance with U.S. GAAP.

Key Components of Results of Operations

Revenues

We derive revenues from the sale of subscriptions to our security and compliance solutions, which are delivered on our cloud platform. Subscriptions to our solutions allow customers to access our cloud-based security and compliance solutions through a unified, web-based interface. Customers generally enter into one year renewable subscriptions. The subscription fee entitles the customer to an unlimited number of scans for a specified number of devices or web applications and, if requested by a customer as part of their subscription, a specified number of physical or virtual scanner appliances. Our physical and virtual scanner appliances are requested by certain customers as part of their subscriptions in order to scan IT infrastructures within their firewalls and do not function without, and are not sold separately from, subscriptions for our solutions. In some limited cases, we also provide certain computer equipment used to extend our Qualys cloud platform into our customers’ private cloud environment. Customers are required to return physical scanner appliances and computer equipment if they do not renew their subscriptions.

We typically invoice our customers for the entire subscription amount at the start of the subscription term. Invoiced amounts are reflected on our condensed consolidated balance sheets as accounts receivable or as cash when collected, and as deferred revenues until earned and recognized ratably over the subscription period. Accordingly, deferred revenues represent the amount billed to customers that has not yet been earned or recognized as revenues, pursuant to subscriptions entered into in current and prior periods.

Cost of Revenues

Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for employees who operate our data centers and provide support services to our customers. Other expenses include depreciation of data center equipment and physical scanner appliances and computer hardware provided to certain customers as part of their subscriptions, expenses related to the use of third-party data centers, amortization of third-party technology licensing fees, amortization of intangibles related to acquisitions, maintenance support, fees paid to contractors who supplement or support our operations center personnel and overhead allocations. We expect to continue to make capital investments to expand and support our data center operations, which will increase the cost of revenues in absolute dollars.

Operating Expenses

Research and Development

Research and development expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our research and development teams. Other expenses include third-party contractor fees, amortization of intangibles related to acquisitions and overhead allocations. All research and development costs are expensed as incurred. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as develop new solutions and capabilities and expect that research and development expenses will increase in absolute dollars.

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Sales and Marketing

Sales and marketing expenses consist primarily of personnel expenses, comprised of salaries, benefits, sales commissions, performance-based compensation and stock-based compensation for our worldwide sales and marketing teams. Other expenses include marketing and promotional events, lead-generation marketing programs, public relations, travel, software licenses and overhead allocations. All costs are expensed as incurred, including sales commissions. Sales commissions are expensed in the quarter in which the related order is received and are paid in the month subsequent to the end of that quarter, which results in increased expenses prior to the recognition of related revenues. Our new sales personnel are typically not immediately productive, and the resulting increase in sales and marketing expenses we incur when we add new personnel may not result in increased revenues if these new sales personnel fail to become productive. The timing of our hiring of sales personnel, or the participation in new marketing events or programs, and the rate at which these generate incremental revenues, may affect our future operating results. We expect to continue to significantly invest in additional sales personnel worldwide and also in more marketing programs to support new solutions on our platform, which will increase sales and marketing expenses in absolute dollars.

General and Administrative

General and administrative expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our executive, finance and accounting, legal and human resources teams, as well as professional services, insurance, fees, and software licenses. We expect that general and administrative expenses will increase in absolute dollars, as we continue to add personnel and incur professional services to support our growth and compliance with legal requirements.

Other Income (Expense), Net

Our other income (expense), net consists primarily of interest and investment income from our short-term and long-term investments; foreign exchange gains and losses, the majority of which result from fluctuations between the U.S. dollar and the Euro, British Pound and Indian Rupee; losses on disposal of property and equipment; and impairment of long-lived assets.

Provision for Income Taxes

We are subject to federal, state and foreign income taxes for jurisdictions in which we operate, and we use estimates in determining our provision for these income taxes and deferred tax assets. Earnings from our non-U.S. activities are subject to income taxes in the local country which are generally higher than U.S. tax rates, and may be subject to U.S. income taxes.

Our tax provision from income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period. Our estimated effective rate for the year differs from the U.S. statutory rate of 21% primarily due to non-deductible stock-based compensation expense, state taxes, foreign income subject to different tax rates than the U.S., and the benefit of U.S. federal income tax credits.

On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law. The new legislation contains significant tax provisions that affect us, including a one-time repatriation tax on accumulated foreign earnings, a reduction of the corporate income tax rate from 35% to 21%, which was effective January 1, 2018, and a change from a worldwide tax system to a modified territorial system.

In accordance with Staff Accounting Bulletin No. 118 ("SAB 118"), the effects of the 2017 Tax Act may be adjusted within a one-year measurement period from the enactment date of the 2017 Tax Act for items that were previously reported as provisional estimates, or where a provisional estimate could not be made. The income tax provision for the three months ended March 31, 2018, does not reflect any adjustment to the provisional estimates recorded in the year ended December 31, 2017. We will continue to assess forthcoming guidance and accounting interpretations on the effects of the 2017 Tax Act and expect to complete our analysis within the measurement period in accordance with the SEC guidance. Such analysis includes both the implications of the newly introduced provisions for Global Intangible

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Low Tax Income and the detailed analysis of historical foreign earnings and potential correlative adjustments to verify the one-time transition tax does not apply.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the tax impact of timing differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the statutory rate change is enacted into law.

We assess the likelihood that deferred tax assets will be realized, and we recognize a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be recognized. This assessment requires judgment as to the likelihood and amounts of future taxable income.

Sales Taxes

We present our revenues net of sales tax in our condensed consolidated statements of operations.

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Results of Operations

The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented.



	Three Months Ended
	March 31,
	2018		2017
	(in thousands)
Condensed Consolidated Statements of Operations data:
Revenues	$	64,878	$	53,121
Cost of revenues ⁽¹⁾	15,901		12,294
Gross profit	48,977		40,827
Operating expenses:
Research and development ⁽¹⁾	12,553		9,823
Sales and marketing ⁽¹⁾	16,233		16,014
General and administrative ⁽¹⁾	11,785		7,334
Total operating expenses	40,571		33,171
Income from operations	8,406		7,656
Other income (expense), net	1,245		453
Income before income taxes	9,651		8,109
Provision for (benefit from) income taxes	509		(13,821		)
Net income	$	9,142	$	21,930


⁽¹⁾	Includes stock-based compensation as follows:



	Three Months Ended
	March 31,
	2018		2017
	(in thousands)
Cost of revenues	$	654	$	501
Research and development	1,841		1,221
Sales and marketing	1,401		1,084
General and administrative	4,995		1,526
Total stock-based compensation	$	8,891	$	4,332

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The following table sets forth selected condensed consolidated statements of operations data for each of the periods presented as a percentage of revenues.



	Three Months Ended
	March 31,
	2018		2017
Revenues	100	%	100	%
Cost of revenues	25		23
Gross profit	75		77
Operating expenses:
Research and development	19		19
Sales and marketing	25		30
General and administrative	18		14
Total operating expenses	62		63
Income from operations	13		14
Other income (expense), net	2		1
Income before income taxes	15		15
Provision for (benefit from) income taxes	1		(26	)
Net income	14	%	41	%

Comparison of Three Months Ended March 31, 2018 and 2017

Revenues



	Three Months Ended
	March 31,				Change
	2018		2017		$		%
	(in thousands, except percentages)
Revenues	$	64,878	$	53,121	$	11,757	22	%

Revenues increased $11.8 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, due to an increase in the purchase of subscriptions from existing customers and new customer subscriptions entered into after March 31, 2017. Of the total increase of $11.8 million, $6.9 million was from customers in the United States and the remaining $4.9 million was from customers in foreign countries. We expect revenue growth from existing and new customers to continue. The growth in revenues reflects the continued demand for our solutions. There was no impact to our revenues as a result of adopting Accounting Standards Codification ("ASC") 606. See Note 4, “Revenue from Contracts with Customers”, to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.

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Cost of Revenues



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
Cost of revenues	$	15,901		$	12,294		$	3,607	29	%
Percentage of revenues	25		%	23		%
Gross profit percentage	75		%	77		%

Cost of revenues increased $3.6 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in personnel expenses of $1.6 million, driven by the increase in the number of employees to support the continued growth of our business; a $0.7 million increase in depreciation expense related to additional computer hardware and software; a $0.6 million increase in amortization expense related to acquired technology resulting from our business acquisitions; increased third-party software license and maintenance expense of $0.4 million; and increased data center costs of $0.3 million as our business continues to grow.

Research and Development Expenses



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
Research and development	$	12,553		$	9,823		$	2,730	28	%
Percentage of revenues	19		%	19		%

Research and development expenses increased $2.7 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in personnel expenses of $2.1 million, driven by additional employees hired to support the growth of our business; increased related facilities costs and expenses of $0.4 million to support our research and development activities; and increased third-party software license and maintenance expense of $0.1 million as our business continues to grow. We continue to significantly invest in and expand our research and development teams to continuously improve our platform and existing solutions, as well as develop new solutions and capabilities.

Sales and Marketing Expenses



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
Sales and marketing	$	16,233		$	16,014		$	219	1	%
Percentage of revenues	25		%	30		%

Sales and marketing expenses increased $0.2 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in headcount expense of $1.1 million driven by additional employees hired to support the growth of our business; increased third-party software license and maintenance expense of $0.7 million; and increased depreciation related to computer software of $0.4 million. These increases were partially offset by a decrease in tradeshow expenses of $1.1 million as well as a decrease of commission expense of $0.8 million resulting from the adoption of ASC 606, resulting in us capitalizing commissions on new business and upsells in the three months ended March 31, 2018 versus expensing all commissions in the three months ended March 31, 2017.

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General and Administrative Expenses



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
General and administrative	$	11,785		$	7,334		$	4,451	61	%
Percentage of revenues	18		%	14		%

General and administrative expenses increased $4.5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily driven by higher stock-based compensation of $3.5 million; increased consulting and outside services fees of $0.5 million; and increased third-party software license and maintenance expense of $0.4 million to support the growth of our business.

Total Other Income (Expense), Net



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
Total other income (expense), net	$	1,245		$	453		$	792	175	%
Percentage of revenues	2		%	1		%

Total other income (expense), net increased by $0.8 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, primarily due to an increase in interest income as our cash and investment balances increased year over year.

Income Taxes



	Three Months Ended
	March 31,						Change
	2018			2017			$		%
	(in thousands, except percentages)
Provision for (benefit from) income taxes	$	509		$	(13,821	)	$	14,330	(104	)%
Effective Tax Rate	5.3		%	(170.4		)%

We recorded an income tax provision of $0.5 million and income tax benefit of $13.8 million for the three months ended March 31, 2018 and 2017, respectively. The increase in income tax provision for the three months ended March 31, 2018 is primarily due to a reduction in the amount of excess benefits of stock-based compensation realized during the quarter, a year-over-year increase in income before taxes and non-deductible stock-based compensation as a result of changes in the tax law for executive compensation.

Liquidity and Capital Resources

At March 31, 2018, our principal source of liquidity was cash, cash equivalents, and short-term and long-term investments of $393.9 million, including $7.8 million held outside of the United States by our foreign subsidiaries. We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. However, if we repatriate these funds, we could be subject to foreign withholding taxes.

We have experienced positive cash flows from operations during the three months ended March 31, 2018 and 2017. We believe our existing cash, cash equivalents, short-term and long-term investments, and cash from operations will be sufficient to fund our operations for at least the next twelve months. Our future capital requirements will depend

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on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing, type and extent of our spending on research and development efforts, international expansion and investment in data centers. We may also seek to invest in or acquire complementary businesses or technologies.

Cash Flows

The following summary of cash flows for the periods indicated has been derived from our condensed consolidated financial statements included elsewhere in this report:



	Three Months Ended
	March 31,
	2018			2017
	(in thousands)
Cash provided by operating activities	$	42,989		$	32,425
Cash used in investing activities	(38,081		)	(1,006		)
Cash provided by (used in) financing activities	1,675			(8,505		)
Net increase in cash and cash equivalents	$	6,583		$	22,914

Cash Flows from Operating Activities

For the three months ended March 31, 2018, cash flows from operating activities of $43.0 million primarily resulted from our net income of approximately $9.1 million, as adjusted for non-cash items including stock-based compensation of $8.9 million and depreciation and amortization expense of $7.0 million; and a decrease in our accounts receivable of $14.5 million due to the timing of customer payments.

In the three months ended March 31, 2017, cash flows from operating activities of $32.4 million primarily resulted from our net income of approximately $21.9 million, as adjusted by an increase in deferred revenues of $8.0 million attributable to our continued growth, and a decrease in our accounts receivable of $5.4 million. These working capital increases were further increased by non-cash items including excess tax benefits included in deferred tax assets of $8.4 million, depreciation and amortization expense of $4.8 million and stock-based compensation of $4.3 million. These increases were partially offset by additions to deferred income tax assets of $22.6 million.

Cash Flows from Investing Activities

For the three months ended March 31, 2018, cash used in investing activities of $38.1 million was attributable to purchases of investments, net of sales and maturities of $32.1 million, and $6.0 million of cash used for capital expenditures, including computer hardware and software for our data centers to support our growth and development, and to purchase physical scanner appliances and computer hardware provided to certain customers as part of their subscriptions.

In the three months ended March 31, 2017, cash used in investing activities of $1.0 million was attributable to $4.5 million of cash used for capital expenditures, including computer hardware and software for our data centers to support our growth and development. This increase was partially offset by sales and maturities of investments, net of purchases of $3.5 million.

Cash Flows from Financing Activities

For the three months ended March 31, 2018, cash provided by financing activities of $1.7 million was attributable to $7.9 million of proceeds from the exercise of stock options, offset by employee payroll taxes paid related to net share settlement of equity awards of $4.0 million, share repurchases of $1.5 million and principal payments under capital lease obligations of $0.7 million.

In the three months ended March 31, 2017, cash used in financing activities of $8.5 million was attributable to payments for taxes related to employee net share settlement of equity awards of $14.1 million, offset by the proceeds from the exercise of stock options of $5.6 million.

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Contractual Obligations

Our principal commitments consist of obligations under our outstanding leases for office space, third-party data centers, office equipment and capital leases. The following table summarizes our contractual cash obligations, including future interest payments, at March 31, 2018 and the effect such obligations are expected to have on our liquidity and cash flows in future periods:



	Payment Due by Period
Contractual Obligations	Total		2018 (remaining nine months)		2019-2020		2021-2022		2023 and thereafter
	(in thousands)
Operating lease obligations	$	48,907	$	6,912	$	11,193	$	8,802	$	22,000
Capital lease obligations	2,894		940		1,900		54		—
Total	$	51,801	$	7,852	$	13,093	$	8,856	$	22,000

On October 14, 2016, we entered into a lease agreement (included in the table above) for our new headquarters office facility. The lease payments commenced on May 1, 2018 and the lease has a ten-year term through April 2028. The total commitment of $38.6 million is payable monthly with escalating rental payments throughout the lease term. In connection with this lease, we have provided the landlord with a $1.2 million standby letter of credit to secure our obligations through the end of the lease term, which was classified as restricted cash in the accompanying condensed consolidated balance sheets.

Operating lease obligations represent our obligations to make payments under the lease agreements for our facilities, data centers, and office equipment leases. During the three months ended March 31, 2018, we made regular payments on our operating lease obligations of $1.0 million.

Capital lease obligations represent financing on data center storage equipment. During the three months ended March 31, 2018, we made regular principal payments on our capital lease obligations of $0.7 million.

Off-Balance Sheet Arrangements

During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities.

Recent Accounting Pronouncements

See Note 1 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in the notes to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the SEC on February 23, 2018, the accounting policies related to revenue recognition, income taxes and stock-based compensation involve the greatest degree of judgment and complexity and have the greatest potential impact on our consolidated financial statements. A critical accounting policy is one that is material to the presentation of our consolidated financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. Except for the changes below, there have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the SEC on February 23, 2018.

We adopted ASC 606 Revenue from Contracts with Customers with a date of initial application of January 1, 2018. We adopted ASC 606 using the modified retrospective method and recognized the cumulative effect as an adjustment to the opening balance of equity at January 1, 2018. Therefore, the comparative information has not been adjusted and continues to be reported under ASC 605. The significant impact of adopting ASC 606 was related to the deferral of sales commission costs for new business and when customers increase their renewal orders (“upsells”). We previously expensed sales commission as incurred. Under ASC 606, sales commissions cost related to new business and upsells are recorded as an asset. We expense the commission cost as a selling expense on a straight-line basis over a period of five years. Five years represents the estimated life of the customer relationship taking into account factors such as peer estimates of technology lives and customer lives as well as our own historical data. Applying the practical expedient in ASC 340-40-25-4, we expense commissions related to contract renewals with a renewal contract term of one year or less. The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets, and other noncurrent assets, respectively, in our condensed consolidated balance sheets.

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Item 3.	Quantitative and Qualitative Disclosures about Market Risk

We have domestic and international operations and we are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate, foreign exchange and inflation risks, as well as risks relating to changes in the general economic conditions in the countries where we conduct business. To reduce certain of these risks, we monitor the financial condition of our large customers and limit credit exposure by collecting subscription fees in advance.

Foreign Currency Risk

Our results of operations and cash flows have been and will continue to be subject to fluctuat