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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

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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.

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Qualys, Inc.

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		Page
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018	4
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018	5
	Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018	6
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018	7
	Condensed Consolidated Statements of Equity for the three and nine months ended September 30, 2019 and 2018	8
	Notes to Condensed Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	45
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	46
Item 1A.	Risk Factors	46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	69
Item 3.	Defaults upon Senior Securities	69
Item 4.	Mine Safety Disclosures	69
Item 5.	Other Information	69
Item 6.	Exhibits	70
	Signatures	71

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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)



	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.

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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.

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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.

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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.

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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

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	Common Stock				Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Total Stockholders’ Equity
	Shares		Amount		Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Total Stockholders’ Equity
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.

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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 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

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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.

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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.

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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, 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.

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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

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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