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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-Q
__________________
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2019
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)
__________________

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of exchange on which registered
Common stock, $0.001 par value per share
QLYS
NASDAQ Stock Market
 
 
 

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 every Interactive Data File required to be submitted 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 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.
Large accelerated filer
x
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
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
 


Table of Contents


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 October 28, 2019 was 38,762,280.


Table of Contents

Qualys, Inc.
TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
Item 1.
 
 
Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II – OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 



3

Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
Qualys, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share and per share data)

 
September 30,
2019
 
December 31, 2018
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
75,615

 
$
41,026

Short-term marketable securities
222,421

 
248,140

Accounts receivable, net of allowance of $558 and $683 as of September 30, 2019 and December 31, 2018, respectively
61,314

 
75,825

Prepaid expenses and other current assets
20,459

 
13,974

Total current assets
379,809

 
378,965

Long-term marketable securities
100,951

 
76,710

Property and equipment, net
58,705

 
61,442

Operating leases - right of use asset
27,043

 

Deferred tax assets, net
18,302

 
26,387

Intangible assets, net
18,316

 
21,976

Goodwill
7,447

 
7,225

Restricted cash
1,200

 
1,200

Other noncurrent assets
14,151

 
11,775

Total assets
$
625,924

 
$
585,680

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
909

 
$
5,588

Accrued liabilities
25,595

 
26,695

Deferred revenues, current
180,304

 
164,624

Operating lease liabilities, current
6,937

 

Total current liabilities
213,745

 
196,907

Deferred revenues, noncurrent
20,156

 
20,423

Operating lease liabilities, noncurrent
30,696

 

Other noncurrent liabilities
304

 
10,361

Total liabilities
264,901

 
227,691

Commitments and contingencies (Note 8)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at September 30, 2019 and December 31, 2018

 

Common stock, $0.001 par value; 1,000,000,000 shares authorized; 38,750,803 and 39,015,034 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively
39

 
39

Additional paid-in capital
345,378

 
330,572

Accumulated other comprehensive income (loss)
2,271

 
(586
)
Retained earnings
13,335

 
27,964

Total stockholders’ equity
361,023

 
357,989

Total liabilities and stockholders’ equity
$
625,924

 
$
585,680


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


4

Table of Contents

Qualys, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2019
 
2018
 
2019
 
2018
Revenues
$
82,671

 
$
71,658

 
$
236,943

 
$
204,689

Cost of revenues
17,108

 
16,511

 
52,354

 
48,660

Gross profit
65,563

 
55,147

 
184,589

 
156,029

Operating expenses:
 
 
 
 
 
 
 
Research and development
16,899

 
12,501

 
50,431

 
38,182

Sales and marketing
17,009

 
15,489

 
51,489

 
50,698

General and administrative
9,106

 
9,040

 
29,961

 
29,731

Total operating expenses
43,014

 
37,030

 
131,881

 
118,611

Income from operations
22,549

 
18,117

 
52,708

 
37,418

Other income (expense), net:
 
 
 
 
 
 
 
Interest expense
(28
)
 
(35
)
 
(98
)
 
(112
)
Interest income
2,142

 
1,651

 
6,391

 
4,193

Other income (expense), net
(328
)
 
(500
)
 
(320
)
 
(836
)
Total other income, net
1,786

 
1,116

 
5,973

 
3,245

Income before income taxes
24,335

 
19,233

 
58,681

 
40,663

Provision (benefit) for income taxes
5,161

 
(4,236
)
 
10,009

 
(2,241)

Net income
$
19,174

 
$
23,469

 
$
48,672

 
$
42,904

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.49

 
$
0.60

 
$
1.24

 
$
1.10

Diluted
$
0.47

 
$
0.56

 
$
1.17

 
$
1.02

Weighted average shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
39,014

 
39,170

 
39,099

 
38,907

Diluted
41,162

 
42,197

 
41,447

 
42,113


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


5

Table of Contents

Qualys, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
19,174

 
$
23,469

 
$
48,672

 
$
42,904

Other comprehensive income (loss):

 

 

 

Available-for-sale marketable securities:
 
 
 
 
 
 
 
Change in net unrealized gain (loss) on marketable securities, net of tax
40

 
(85
)
 
1,419

 
(427
)
Reclassification adjustment for net realized gain (loss) included in net income
(18
)
 
154

 
25

 
249

Total change in unrealized gain (loss) on marketable securities, net of tax
22

 
69

 
1,444

 
(178
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gain, net of tax
982

 

 
$
1,423

 
$

Reclassification adjustment for net realized gain (loss) included in net income
27

 

 
(10
)
 

Total change in unrealized gain (loss) on cash flow hedges, net of tax
1,009

 

 
1,413

 

Other comprehensive income (loss), net of tax
1,031

 
69

 
2,857

 
(178
)
Comprehensive income
$
20,205

 
$
23,538

 
$
51,529

 
$
42,726


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



6

Table of Contents

Qualys, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)

 
Nine Months Ended
 
September 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
48,672

 
$
42,904

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
23,486

 
21,224

Bad debt expense
156

 

Loss on disposal of property and equipment
196

 
31

Stock-based compensation
25,163

 
22,672

Amortization of premiums and (accretion) of discounts on marketable securities
(1,402
)
 
(586
)
Deferred income taxes
7,296

 
(4,024
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
14,355

 
5,800

Prepaid expenses and other assets
(6,485
)
 
(5,733
)
Accounts payable
(1,336
)
 
182

Accrued liabilities
1,275

 
5,803

Deferred revenues
15,413

 
12,351

Other non-current liabilities
160

 
(1,804
)
Net cash provided by operating activities
126,949


98,820

Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(259,286
)
 
(242,056
)
Sales and maturities of marketable securities
263,874

 
218,865

Purchases of property and equipment
(19,473
)
 
(19,496
)
Business combinations
(1,850
)
 
(3,359
)
Purchase of privately-held investment
(625
)
 
(2,500
)
Net cash used in investing activities
(17,360
)
 
(48,546
)
Cash flows from financing activities:
 
 
 
Repurchase of common stock
(73,877
)
 
(46,542
)
Proceeds from exercise of stock options
11,014

 
20,896

Payments for taxes related to net share settlement of equity awards
(10,864
)
 
(12,010
)
Principal payments under finance lease obligations
(1,273
)
 
(1,203
)
Net cash used in financing activities
(75,000
)
 
(38,859
)
Effect of exchange rate changes on cash and cash equivalents

 
(42
)
Net increase in cash, cash equivalents and restricted cash
34,589

 
11,373

Cash, cash equivalents and restricted cash at beginning of period
42,226

 
87,791

Cash, cash equivalents and restricted cash at end of period
$
76,815

 
$
99,164


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


7

Table of Contents

Qualys, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY 
(unaudited)
(in thousands, except share data)

 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other
Comprehensive
Income (Loss)
 
Retained Earnings
 
Total
Stockholders’
Equity
 
 
Shares
 
Amount
 
Balances at December 31, 2018
 
39,015,034

 
$
39

 
$
330,572

 
$
(586
)
 
$
27,964

 
$
357,989

Net income
 

 

 

 

 
13,266

 
13,266

Other comprehensive income, net of tax
 

 

 

 
896

 

 
896

Issuance of common stock upon exercise of stock options
 
152,164

 

 
4,047

 

 

 
4,047

Repurchase of common stock
 
(94,090
)
 

 
(1,129
)
 

 
(6,742
)
 
(7,871
)
Issuance of common stock upon vesting of restricted stock units
 
99,601

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(38,877
)
 

 
(3,367
)
 

 

 
(3,367
)
Stock-based compensation
 

 

 
8,443

 

 

 
8,443

Balances at March 31, 2019
 
39,133,832

 
39

 
338,566

 
310

 
34,488

 
373,403

Net income
 

 

 

 

 
16,232

 
16,232

Other comprehensive income, net of tax
 

 

 

 
930



 
930

Issuance of common stock upon exercise of stock options
 
192,687

 

 
4,944

 

 

 
4,944

Repurchase of common stock
 
(183,948
)
 

 
(2,207
)
 

 
(14,038
)
 
(16,245
)
Issuance of common stock upon vesting of restricted stock units
 
126,754

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(45,250
)
 

 
(4,044
)
 

 

 
(4,044
)
Stock-based compensation
 

 

 
8,378

 

 

 
8,378

Balances at June 30, 2019
 
39,224,075

 
39

 
345,637

 
1,240

 
36,682

 
383,598

Net income
 





 

 
19,174

 
19,174

Other comprehensive income, net of tax
 

 

 

 
1,031



 
1,031

Issuance of common stock upon exercise of stock options
 
68,059

 

 
2,023

 

 

 
2,023

Repurchase of common stock
 
(603,417
)
 

 
(7,240
)
 

 
(42,521
)
 
(49,761
)
Issuance of common stock upon vesting of restricted stock units
 
103,206

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(41,120
)
 

 
(3,453
)
 

 

 
(3,453
)
Stock-based compensation
 

 

 
8,411

 

 

 
8,411

Balances at September 30, 2019
 
38,750,803

 
39

 
345,378

 
2,271

 
13,335

 
361,023




8

Table of Contents


 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained Earnings
 
Total
Stockholders’
Equity
 
 
Shares
 
Amount
 
Balances at December 31, 2017
 
38,598,117

 
$
39

 
$
304,155

 
$
(574
)
 
$
39,924

 
$
343,544

Adoption of revenue recognition standard
 

 

 

 

 
2,711

 
2,711

Net income
 

 

 

 

 
9,142

 
9,142

Other comprehensive loss, net of tax
 

 

 

 
(391
)
 

 
(391
)
Issuance of common stock upon exercise of stock options
 
285,997

 

 
7,933

 

 

 
7,933

Repurchase of common stock
 
(21,288
)
 

 
(255
)
 

 
(1,226
)
 
(1,481
)
Issuance of common stock upon vesting of restricted stock units
 
158,561

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(63,695
)
 

 
(4,030
)
 

 

 
(4,030
)
Stock-based compensation
 

 

 
8,891

 

 

 
8,891

Balances at March 31, 2018
 
38,957,692

 
39

 
316,694

 
(965
)
 
50,551

 
366,319

Net income
 

 

 

 

 
10,293

 
10,293

Other comprehensive income, net of tax
 

 

 

 
144

 

 
144

Issuance of common stock upon exercise of stock options
 
144,851

 

 
4,239

 

 

 
4,239

Repurchase of common stock
 
(235,539
)
 

 
(2,826
)
 

 
(15,049
)
 
(17,875
)
Issuance of common stock upon vesting of restricted stock units
 
184,008

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(65,214
)
 

 
(4,904
)
 

 

 
(4,904
)
Stock-based compensation
 

 

 
7,023

 

 

 
7,023

Balances at June 30, 2018
 
38,985,798

 
39

 
320,226

 
(821
)
 
45,795

 
365,239

Net income
 

 

 

 

 
23,469

 
23,469

Other comprehensive income, net of tax
 

 

 

 
69

 

 
69

Issuance of common stock upon exercise of stock options
 
611,431

 

 
8,721

 

 

 
8,721

Repurchase of common stock
 
(310,815
)
 

 
(3,729
)
 

 
(23,456
)
 
(27,185
)
Issuance of common stock upon vesting of restricted stock units
 
90,956

 

 

 

 

 

Taxes related to net share settlement of equity awards
 
(35,881
)
 

 
(3,075
)
 

 

 
(3,075
)
Stock-based compensation
 

 

 
6,902

 

 

 
6,902

Balances at September 30, 2018
 
39,341,489

 
39

 
329,045

 
(752
)
 
45,808

 
374,140



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


9

Table of Contents
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 wholly-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 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 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, 2018, 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 and nine months ended September 30, 2019 are not necessarily indicative of the results of operations expected for the entire year ending December 31, 2019 or for any other future annual or interim periods. 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, 2018, filed with the SEC on February 27, 2019. Certain corrections have been made to the prior year disclosures of revenue by sales channel (Note 4) and property and equipment, net by geographic area (Note 13) to conform to current year presentation. These corrections have no effect on net income, total assets or stockholders’ equity as previously reported.


Use of Estimates
The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date of the condensed consolidated financial statements and the reported results of operations during the reporting period. The Company’s management regularly assesses these estimates, which primarily affect revenue recognition, the valuation of accounts receivable, goodwill and intangible assets, capitalization of internally developed software, stock-based compensation and the provision for income taxes. Actual results could differ from those estimates and such differences may be material to the accompanying unaudited condensed consolidated financial statements.

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, to date primarily cash and accounts receivable (non-designated forward contracts), as well as to manage foreign currency fluctuation risk related to forecasted transactions (designated cash flow hedges). Open contracts are recorded within prepaid expenses and other current assets or accrued liabilities in


10

Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)


the condensed consolidated balance sheets. Gains and losses resulting from currency exchange rate movements on non-designated forward contracts are recognized in other income (expense), net. Any gains or losses from designated cash flow hedges are first accumulated in other comprehensive income ("AOCI") and then reclassified to revenue when the hedged item impacts the condensed consolidated statements of operations.

The cash flow effects of the Company's derivative contracts for the nine months ended September 30, 2019 were included within net cash provided by operating activities on its condensed consolidated statements of cash flows. As of September 30, 2019, the Company had 19.9 million and £9.8 million of notional amounts outstanding on designated cash flow hedges. The Company had no designated cash flow hedges as of September 30, 2018.

Stock-Based Compensation

The Company recognizes the fair value of its employee stock options and restricted stock units over the requisite service period for those awards ultimately expected to vest. The fair value of each option is estimated on date of grant using the Black-Scholes-Merton option pricing model and the fair value of each restricted stock unit is based on the fair value of the Company's stock on the date of grant. Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from original estimates.

The Company has issued performance-based awards and accounts for these awards as stock-based compensation with multiple performance conditions. For these performance-based awards, the Company records compensation expense for only the performance milestones that are probable of being achieved, with such expense recorded on a straight-line basis over the expected vesting period. The Company reassesses performance-based estimates each reporting period and, if the estimated service period changes, the Company recognizes all remaining compensation expense over the remaining service period and, if the probability of achievement changes to or from “probable,” the Company recognizes the cumulative effect. For the three and nine months ended September 30, 2019, the Company recorded approximately $0.2 million and $0.7 million of stock-based compensation cost for these awards, respectively.

Internally Developed Software Costs

The Company capitalizes certain costs incurred to develop new internal-use software. Capitalized costs include salaries, benefits, and stock-based compensation charges for employees that are directly involved in developing its cloud security platform during the application development stage. These capitalized costs are included in other noncurrent assets on the accompanying condensed consolidated balance sheets. Upon general release, such costs are amortized on a straight-line basis over an estimated useful life of three years. Amortization of internally developed software is recorded to cost of revenues. Capitalization of internally developed software cost was $0.1 million and $0.5 million for the three and nine months ended September 30, 2019, respectively. Unamortized cost for capitalized internally developed software was $1.6 million at September 30, 2019 and $1.2 million at December 31, 2018. Amortization expense for capitalized internally developed software was insignificant for the three and nine months ended September 30, 2019. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. 

Cost Method Investments
In the second quarter of fiscal 2018, the Company invested $2.5 million in preferred stock of a privately-held company. The investment has been accounted for using the cost method and included in other noncurrent assets on the accompanying condensed consolidated balance sheets. The Company's cost method investment is assessed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company has not recorded any dividends or other-than-temporary impairment charges related to its cost method investment. The fair value of the investment is not readily available, and there are no quoted market prices for the investment. During the three months ended June 30, 2019, the Company made an advance payment of $0.6 million to the investee for certain development work, which is recorded in other noncurrent assets on the condensed consolidated balance sheet. During the three months ended September 30, 2019, the Company made an additional investment of $0.6 million in a convertible security issued by this investee and recorded it in other current assets on the condensed consolidated balance sheet. 



11

Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)



Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, Leases (Topic 842), which requires lessees to recognize all leases, including operating leases, on the balance sheet as a lease asset and 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. In July 2018, the FASB issued ASU 2018-11, Targeted Improvements - Leases (Topic 842). This update provides an optional transition method that allows entities to elect to apply the standard prospectively at its effective date, versus recasting the prior periods presented. If elected, an entity would recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Pursuant to the leasing criteria, most of the Company's leased space and equipment leases will be required to be accounted for as right-of-use assets ("ROU") on the balance sheet with offsetting financing obligations. In the statement of operations, what was formerly rent expense for operating leases will be lease expense; and finance leases will be bifurcated into amortization of right-of-use assets and interest on lease liabilities. The Company adopted the ASU utilizing the current period adjustment method on January 1, 2019, and recognized an ROU asset of $30.8 million and a lease liability of $41.6 million on its condensed consolidated financial statements. As of January 1, 2019, $3.9 million of deferred rent and $6.9 million related to tenant improvement allowance was removed upon adoption. As part of this adoption, the Company elected the package of transitional practical expedients to not reassess (1) whether any contracts that existed prior to adoption have or contain leases, (2) the classification of existing leases or (3) initial direct costs for existing leases. The Company also elected to make the accounting policy election for short-term leases, permitting the Company to not apply the recognition requirements of this standard to short-term leases with terms of 12 months or less.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The Company adopted this guidance as of January 1, 2019. The adoption of this ASU did not have a material impact on the Company's 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 Company adopted this ASU during the first quarter of fiscal 2019 and the adoption did not have a material impact on the Company's condensed consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs related to internal-use software. ASU 2018-15 is effective for the Company beginning in the first quarter of fiscal 2020 and early adoption is permitted.  The adoption of this ASU is not expected to have a material impact on the Company's consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments–Credit Losses (Topic 326) as modified by subsequently issued ASU No. 2018-19, 2019-04 and 2019-05, which introduces a new accounting model, Current Expected Credit Losses ("CECL"). CECL requires earlier recognition of credit losses, while also providing additional transparency about credit risk. CECL utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses at the time the financial asset is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The ASUs are effective for the Company beginning in the first quarter of fiscal 2020. The adoption of the ASUs is not expected to have a material impact on the Company's consolidated financial statements.


12

Table of Contents
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, marketable securities, derivative foreign currency forward contracts and commitments associated with prior business combinations 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 estimated fair value of commitments from prior acquisitions are determined based on management’s estimate of fair value using a Monte Carlo simulation model, which uses Level 3 inputs for fair value measurements. As of September 30, 2019, management estimated the fair value of such commitments to be zero. During the three months ended September 30, 2019, the Company made an investment of $0.6 million in a convertible security issued by its cost method investee. The estimated fair value of the investment was determined based on Level 3 inputs. As of September 30, 2019, management estimated that the fair value of the investment equaled its carrying value.



13

Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)


The Company's cash and cash equivalents, and marketable securities consist of the following:
 
September 30, 2019
  
Amortized Cost
 
Unrealized Gains
 
Unrealized (Losses)
 
Fair Value
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash
$
66,453

 
$

 
$

 
$
66,453

Money market funds
249

 

 

 
249

Commercial paper
8,913

 

 

 
8,913

Total
75,615

 

 

 
75,615

Short-term marketable securities:
 
 
 
 
 
 
 
Commercial paper
3,386

 

 

 
3,386

Corporate bonds
30,038

 
70

 
(9
)
 
30,099

Asset-backed securities
1,051

 
1

 

 
1,052

U.S. government agencies
187,654

 
235

 
(5
)
 
187,884

Total
222,129

 
306

 
(14
)
 
222,421

Long-term marketable securities:
 
 
 
 
 
 
 
Asset-backed securities
39,831

 
252

 

 
40,083

U.S. government agencies
27,874

 
382

 

 
28,256

Corporate bonds
32,376

 
242

 
(6
)
 
32,612

Total
100,081

 
876

 
(6
)
 
100,951

Total
$
397,825

 
$
1,182

 
$
(20
)
 
$
398,987

 
December 31, 2018
  
Amortized Cost
 
Unrealized Gains
 
Unrealized (Losses)
 
Fair Value
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash
$
40,913

 
$

 
$

 
$
40,913

Money market funds
113

 

 

 
113

Total
41,026

 

 

 
41,026

Short-term marketable securities:
 
 
 
 
 
 
 
Commercial paper
3,237

 

 

 
3,237

Corporate bonds
30,906

 

 
(84
)
 
30,822

Asset-backed securities
10,447

 

 
(15
)
 
10,432

U.S. government agencies
203,734

 
9

 
(94
)
 
203,649

Total
248,324

 
9

 
(193
)
 
248,140

Long-term marketable securities:
 
 
 
 
 
 
 
Asset-backed securities
22,945

 
10

 
(28
)
 
22,927

U.S. government agencies
18,804

 

 
(53
)
 
18,751

Corporate bonds
35,322

 
3

 
(293
)
 
35,032

Total
77,071

 
13

 
(374
)
 
76,710

Total
$
366,421

 
$
22

 
$
(567
)
 
$
365,876





14

Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)


The following table shows the changes to AOCI related to available-for-sale marketable securities for the nine months ended September 30, 2019 (in thousands):

 
Unrealized Gain (Loss), net
AOCI for available-for sale marketable securities balance at December 31, 2018
$
(545
)
Change in net unrealized gain, net of tax
1,419

Amounts reclassified for net realized gain included in net income
25

Total change in unrealized gain (loss), net of tax
1,444

AOCI for available-for sale marketable securities balance at September 30, 2019
$
899



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

 
September 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
(in thousands)
Commercial paper
$

 
$
12,299

 
$

 
$
12,299

U.S. government agencies

 
216,140

 

 
216,140

Corporate bonds

 
62,711

 

 
62,711

Asset-backed securities

 
41,135

 

 
41,135

Total
$

 
$
332,285

 
$

 
$
332,285


 
December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
(in thousands)
Commercial paper
$

 
$
3,237

 
$

 
$
3,237

U.S. government agencies

 
222,400

 

 
222,400

Corporate bonds

 
65,854

 

 
65,854

Asset-backed securities

 
33,359

 

 
33,359

Total
$

 
$
324,850

 
$

 
$
324,850



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 marketable securities classified as available-for-sale by contractual, or effective, maturity:

 
September 30, 2019
 
Mature within
One Year
 
Mature after One Year through Two Years
 
Mature over Two Years
 
Fair Value
 
(in thousands)
Commercial paper
$
12,299

 
$

 
$