QLYS-2013 Q3
Table of Contents

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 September 30, 2013

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)

1600 Bridge Parkway, Redwood City, California 94065
(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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
 
Accelerated filer
x
 
Non-accelerated filer
o
 
Smaller reporting company
o
 
 
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

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 31, 2013 was 32,251,783.


Table of Contents

Qualys, Inc.
TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
Item 1.
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II – OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2

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, 2013
 
December 31, 2012
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
42,118

 
$
34,885

Short-term investments
58,748

 
83,547

Accounts receivable, net of allowance of $381 and $331 at September 30, 2013 and December 31, 2012, respectively
25,022

 
24,545

Prepaid expenses and other current assets
5,116

 
4,377

Total current assets
131,004

 
147,354

Restricted cash

 
114

Long-term investments
24,805

 

Property and equipment, net
22,493

 
18,148

Intangible assets, net
2,492

 
2,811

Goodwill
317

 
317

Other noncurrent assets
564

 
1,574

Total assets
$
181,675

 
$
170,318

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,097

 
$
2,031

Accrued liabilities
7,950

 
7,803

Deferred revenues, current
61,389

 
56,497

Capital lease obligations, current
1,071

 
1,183

Total current liabilities
71,507

 
67,514

Deferred revenues, noncurrent
8,456

 
8,616

Income taxes payable, noncurrent
684

 
594

Other noncurrent liabilities
533

 
1,231

Capital lease obligations, noncurrent

 
808

Total liabilities
81,180

 
78,763

Commitments and contingencies (Note 5)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at September 30, 2013 and December 31, 2012

 

Common stock, $0.001 par value; 1,000,000,000 shares authorized, 32,237,969 and 31,420,028 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
32

 
31

Additional paid-in capital
174,056

 
166,651

Accumulated other comprehensive loss
(1,080
)
 
(1,035
)
Accumulated deficit
(72,513
)
 
(74,092
)
Total stockholders’ equity
100,495

 
91,555

Total liabilities and stockholders’ equity
$
181,675

 
$
170,318


See accompanying Notes to Condensed Consolidated Financial Statements

3

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,
 
2013
 
2012
 
2013
 
2012
Revenues
$
27,749

 
$
23,382

 
$
78,923

 
$
66,763

Cost of revenues
6,415

 
4,634

 
18,134

 
13,423

Gross profit
21,334

 
18,748

 
60,789

 
53,340

Operating expenses:
 
 
 
 
 
 
 
Research and development
5,151

 
5,076

 
15,739

 
15,325

Sales and marketing
10,411

 
8,797

 
30,739

 
27,827

General and administrative
4,277

 
3,154

 
12,226

 
8,811

Total operating expenses
19,839

 
17,027

 
58,704

 
51,963

Income from operations
1,495

 
1,721

 
2,085

 
1,377

Other income (expense), net:
 
 
 
 
 
 
 
Interest expense
(7
)
 
(38
)
 
(37
)
 
(153
)
Interest income
115

 
1

 
273

 
2

Other income (expense), net
(84
)
 
60

 
(370
)
 
(44
)
Total other income (expense), net
24

 
23

 
(134
)
 
(195
)
Income before provision for income taxes
1,519

 
1,744

 
1,951

 
1,182

Provision for income taxes
210

 
77

 
372

 
77

Net income
$
1,309

 
$
1,667

 
$
1,579

 
$
1,105

Net income attributable to common stockholders
$
1,307

 
$
415

 
$
1,577

 
$
264

Net income per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.04

 
$
0.07

 
$
0.05

 
$
0.05

Diluted
$
0.04

 
$
0.06

 
$
0.04

 
$
0.04

Weighted average shares used in computing net income per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
32,088

 
5,843

 
31,789

 
5,540

Diluted
36,247

 
26,545

 
35,704

 
25,972


See accompanying Notes to Condensed Consolidated Financial Statements

4

Table of Contents

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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
1,309

 
$
1,667

 
$
1,579

 
$
1,105

Change in foreign currency translation gain (loss), net of zero tax
(12
)
 
41

 
(73
)
 
(17
)
Available-for-sale investments:
 
 
 
 
 
 
 
Change in net unrealized gain on investments, net of zero tax
52

 

 
37

 

Less: reclassification adjustment for net gain included in net income
(1
)
 

 
(9
)
 

Net change, net of zero tax
51

 

 
28

 

Other comprehensive income (loss), net
39

 
41

 
(45
)
 
(17
)
Comprehensive income
$
1,348

 
$
1,708

 
$
1,534

 
$
1,088


See accompanying Notes to Condensed Consolidated Financial Statements



5

Table of Contents

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

 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
1,579

 
$
1,105

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
7,050

 
5,397

Bad debt expense
211

 
182

Loss on disposal of property and equipment
12

 
3

Stock-based compensation
3,808

 
2,583

Non-cash interest expense

 
24

Amortization of premiums on investments
188

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(688
)
 
(2,884
)
Prepaid expenses and other assets
229

 
147

Accounts payable
(939
)
 
(542
)
Accrued liabilities
(608
)
 
(1,529
)
Deferred revenues
4,732

 
6,415

Other noncurrent liabilities
(383
)
 
(232
)
Net cash provided by operating activities
15,191

 
10,669

Cash flows from investing activities:
 
 
 
Purchases of investments
(113,689
)
 

Sales and maturities of investments
113,524

 

Purchases of property and equipment
(10,364
)
 
(8,104
)
Release of restricted cash
114

 

Net cash used in investing activities
(10,415
)
 
(8,104
)
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
3,374

 
1,998

Income tax benefits from exercise of stock options
59

 

Principal payments under capital lease obligations
(920
)
 
(1,763
)
Payment of consideration related to acquisition

 
(1,000
)
Payment for offering costs in connection with initial public offering

 
(560
)
Net cash provided by (used in) financing activities
2,513

 
(1,325
)
Effect of exchange rate changes on cash and cash equivalents
(56
)
 
16

Net increase in cash and cash equivalents
7,233

 
1,256

Cash and cash equivalents at beginning of period
34,885

 
24,548

Cash and cash equivalents at end of period
$
42,118

 
$
25,804

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Purchases of property and equipment included in accrued liabilities
$
731

 
$

Vesting of early exercised common stock options
$
204

 
$
86

Deferred offering costs not yet paid
$

 
$
1,973

Issuance of common stock for acquisition of license
$

 
$
51


See accompanying Notes to Condensed Consolidated Financial Statements


6

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”) was incorporated in the state of Delaware on December 30, 1999. The Company is headquartered in Redwood City, California and has majority-owned subsidiaries throughout the world. The Company is a pioneer and leading provider of cloud 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 QualysGuard 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, 2012, 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 month periods ended September 30, 2013 is not necessarily indicative of the results of operations expected for the entire year ending December 31, 2013 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, 2012 filed with the SEC on March 5, 2013.

Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications did not change previously reported total assets, liabilities, stockholders' equity, income from operations or net income.

Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany transactions and balances have been eliminated upon consolidation.

Use of Estimates
The preparation of the 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 contingent 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, common stock, stock-based compensation and the valuation allowances associated with deferred tax assets. Actual results could differ from those estimates and such differences may be material to the accompanying condensed consolidated financial statements.

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Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Concentration of Credit Risk
The Company invests its cash, cash equivalents and investments with major financial institutions. Cash balances with any one institution at times may be in excess of federally insured limits. Cash equivalents and investments are invested in high-quality investment grade financial instruments and are diversified. The Company has not experienced any other-than-temporary losses in such accounts and believes it is not exposed to any significant credit risk.

Credit risk with respect to accounts receivable is dispersed due to the large number of customers. In addition, the Company’s credit risk is mitigated by the relatively short collection period. Collateral is not required for accounts receivable. The Company maintains an allowance for potential credit losses based upon the expected collectability of accounts receivable. The Company writes off its receivables when collectability is deemed to be doubtful. As of September 30, 2013 and December 31, 2012, no customer or channel partner accounted for more than 10% of the Company's accounts receivable balance.

Cash, Cash Equivalents, Short-Term and Long-Term Investments
Cash and cash equivalents include cash held in banks and highly liquid money market funds, commercial paper and corporate bonds, all with original maturities of three months or less when acquired. The Company’s investments consist of fixed-income U.S. government agency securities, corporate bonds, municipal bonds, asset-backed securities and commercial paper. Management determines the appropriate classification of the Company's investments at the time of purchase and reevaluates such designation at each balance sheet date. The Company classifies its investments as either short-term or long-term based on each instrument's underlying contractual maturity date.

Cash is stated at cost, which approximates fair market value. Cash equivalents and short-term and long-term investments are classified as available-for-sale and are carried at fair value. Unrealized gains and losses in fair value are reported in other comprehensive income (loss). When the available-for-sale securities are sold, cost is based on the specific identification method, and the realized gains and losses are included in other income (expense) in the condensed consolidated statements of operations. Short-term and long-term investments are reviewed quarterly for impairment that is deemed to be other-than-temporary. An investment is considered other-than-temporarily impaired when its fair value is below its amortized cost and (1) there is an intent to sell the security, (2) it is “more likely than not” that the security will be sold before recovery of its amortized cost basis or (3) the present value of expected cash flows from the investment is not expected to recover the entire amortized cost basis. Declines in value that are considered to be other-than-temporary and adjustments to amortized cost for the amortization of premiums and the accretion of discounts are recorded in other income (expense). Interest and dividends are recorded in interest income as earned.

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


Recent Accounting Pronouncements
Under the Jumpstart Our Business Startups Act (the "JOBS Act"), the Company meets the definition of an “emerging growth company.” The Company has irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required from non-emerging growth companies.

In February 2013, the FASB issued an update to ASC 220: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under this update, an entity is required to provide information about the amounts reclassified out of accumulated other comprehensive income (”AOCI”) by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. The Company adopted this standard in the first quarter of 2013, and the adoption of this standard did not have a material impact on the condensed consolidated financial statements. Amounts reclassified out of AOCI are recorded in interest income on the condensed consolidated statements of operations.

In July 2013, the FASB issued ASU 2013-11: Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This update provides guidance on the financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit should be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the tax law. The Company will adopt this amendment as of January 2014. The result of adoption may be to offset certain long-term liabilities to long-term deferred tax assets and the adoption will not result in a change to the tax provision. The Company does not believe that the impact on the balance sheet will be significant.


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 cash and certain cash equivalents, accounts receivable, restricted cash, accounts payable, and other current liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these balances.

The Company measures and reports certain cash equivalents, investments and derivative forward currency 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.


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

The Company's financial instruments consist of assets 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, municipal bonds and asset backed securities and derivative financial instruments consisting of forward currency 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.

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

 
 
September 30, 2013
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
25,434

 
$

 
$

 
$
25,434

Money market funds
 
5,086

 

 

 
5,086

Commercial paper
 
11,597

 
1

 

 
11,598

Total
 
42,117

 
1

 

 
42,118

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
43,960

 
14

 
(1
)
 
43,973

Corporate bonds
 
9,640

 
7

 

 
9,647

Municipal bonds
 
1,127

 

 
(1
)
 
1,126

U.S. government agencies
 
4,001

 
1

 

 
4,002

Total
 
58,728

 
22

 
(2
)
 
58,748

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
3,996

 
3

 
(1
)
 
3,998

U.S. government agencies
 
4,711

 
2

 

 
4,713

Corporate bonds
 
16,083

 
13

 
(2
)
 
16,094

Total
 
24,790

 
18

 
(3
)
 
24,805

Total
 
$
125,635

 
$
41

 
$
(5
)
 
$
125,671



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

 
 
December 31, 2012
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
23,419

 
$

 
$

 
$
23,419

Money market funds
 
170

 

 

 
170

Commercial paper
 
11,294

 
2

 

 
11,296

Total
 
34,883

 
2

 

 
34,885

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
21,078

 
2

 

 
21,080

U.S. government agencies
 
62,463

 
4

 

 
62,467

Total
 
83,541

 
6

 

 
83,547

Restricted cash - cash
 
114

 

 

 
114

Total
 
$
118,538

 
$
8

 
$

 
$
118,546


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:

 
 
September 30, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$

 
$
55,571

 
$

 
$
55,571

U.S. government agencies
 

 
8,715

 

 
8,715

Municipal bonds
 

 
1,126

 

 
1,126

Corporate bonds
 

 
25,741

 

 
25,741

Asset-backed securities
 

 
3,998

 

 
3,998

Total
 
$

 
$
95,151

 
$

 
$
95,151


 
 
December 31, 2012
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$

 
$
32,376

 
$

 
$
32,376

U.S. government agencies
 

 
62,467

 

 
62,467

Total
 
$

 
$
94,843

 
$

 
$
94,843



11

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

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

 
 
September 30, 2013
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
55,571

 
$

 
$

 
$
55,571

U.S. government agencies
 
4,002

 
4,713

 

 
8,715

Municipal bonds
 
1,126

 

 

 
1,126

Corporate bonds
 
9,647

 
16,094

 

 
25,741

Asset-backed securities
 

 

 
3,998

 
3,998

Total
 
$
70,346

 
$
20,807

 
$
3,998

 
$
95,151


 
 
December 31, 2012
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
32,376

 
$

 
$

 
$
32,376

U.S. government agencies
 
62,467

 

 

 
62,467

Total
 
$
94,843

 
$

 
$

 
$
94,843


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 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. The Company does not enter into derivative financial instruments for trading or speculative purposes.

At September 30, 2013, the Company had two outstanding forward contracts with notional amounts of 4.2 million Euros and 1.9 million British pounds, both of which expired on October 31, 2013. At December 31, 2012, the Company had one outstanding forward contract with a notional amount of 10.7 million Euros, which expired on January 31, 2013. These forward contracts were entered into at the end of each month, and thus the fair value of these contracts was $0 at September 30, 2013 and December 31, 2012. The Company recorded losses of $0.4 million and $0.6 million from these contracts for the three and nine months ended September 30, 2013, respectively. These were partially offset by foreign currency transaction gains of $0.3 million and $0.1 million for the three and nine months ended September 30, 2013, respectively. The Company recorded losses of $0.4 million and $0.1 million from these contracts for the three and nine months ended September 30, 2012, respectively. These were offset by foreign currency transaction gains of $0.4 million and $49,000 for the three and nine months ended September 30, 2012, respectively. These derivatives did not meet the criteria to be designated as hedges. These instruments were valued using Level 2 inputs.

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


12

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


NOTE 3.
Property and Equipment, Net

Property and equipment, which includes assets under capital lease, consists of the following:
 
September 30,
 
December 31,
 
2013
 
2012
 
(in thousands)
Computer equipment
$
25,613

 
$
18,798

Computer software
9,139

 
6,327

Furniture, fixtures and equipment
1,758

 
1,545

Scanner appliances
16,646

 
16,470

Leasehold improvements
1,876

 
1,672

Total property and equipment
55,032

 
44,812

Less: accumulated depreciation and amortization
(32,539
)
 
(26,664
)
Property and equipment, net
$
22,493

 
$
18,148


Assets held under capital lease included in computer software at September 30, 2013 and December 31, 2012 totaled approximately $3.8 million. The related accumulated depreciation at September 30, 2013 and December 31, 2012 totaled $1.7 million and $1.2 million, respectively. The capital lease obligations are secured by the related software.

Physical scanner appliances and other computer equipment that are or will be subject to subscriptions by customers have a net carrying value of $4.9 million and $5.5 million at September 30, 2013 and December 31, 2012, respectively, including assets that have not been placed in service of $1.0 million and $1.5 million, respectively. Other fixed assets not placed in service, included in computer equipment and leasehold improvements, relate to new information technology systems and tenant improvements and totaled approximately $1.7 million at September 30, 2013 and December 31, 2012. Depreciation and amortization expense relating to property and equipment, including capitalized leases, was $2.4 million and $1.7 million for three months ended September 30, 2013 and 2012, respectively and $6.7 million and $5.1 million for the nine months ended September 30, 2013 and 2012, respectively.

13

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

NOTE 4.
Goodwill and Intangible Assets, Net

Intangible assets consist primarily of existing technology, patent license and non-competition agreements 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):
 
 
 
 
 
September 30, 2013
 
December 31, 2012
 
Estimated Lives
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Accumulated Amortization
 
Net Book Value
Existing technology
7 years
 
$
1,910

 
(842
)
 
$
1,068

 
$
(637
)
 
$
1,273

Patent license
14 years
 
1,388

 
(297
)
 
1,091

 
(223
)
 
1,165

Non-competition agreements and other
3 years
 
171

 
(133
)
 
38

 
(93
)
 
78

     Total intangibles subject to amortization
 
 
$
3,469

 
$
(1,272
)
 
2,197

 
$
(953
)
 
2,516

Intangible assets not subject to amortization
 
 
 
 
 
 
295

 
 
 
295

     Total intangible assets, net
 
 
 
 
 
 
$
2,492

 
 
 
$
2,811


Intangibles amortization expense was $0.1 million for the three months ended September 30, 2013 and 2012, and $0.3 million for the nine months ended September 30, 2013 and 2012.

As of September 30, 2013, the Company expects amortization expense in future periods to be as follows (in thousands):
Remainder of 2013
$
98

2014
392

2015
385

2016
372

2017
281

2018 and thereafter
669

Total expected future amortization expense
$
2,197


Goodwill, which is not subject to amortization, totaled $0.3 million as of September 30, 2013 and December 31, 2012.


14

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

NOTE 5.
Commitments and Contingencies
Leases
The Company leases certain computer equipment and its corporate office and data center facilities under noncancelable operating leases for varying periods through 2019. The Company has also entered into capital lease obligations, with varying interest rates from 1.8% to 4.0%, a portion of which are secured by the related computer software as of September 30, 2013 and December 31, 2012.

In 2011, the Company entered into a $3.1 million financing arrangement for computer software, accounted for as a capital lease, with minimum quarterly payments scheduled through 2014. In connection with this transaction, the Company also has minimum obligations for related maintenance and support, which was amended in June 2013. The minimum obligations were $0.4 million and $1.6 million at September 30, 2013 and December 31, 2012, respectively. Such obligations for maintenance and support are recorded in current liabilities in the condensed consolidated balance sheets at September 30, 2013 and current and noncurrent liabilities at December 31, 2012.

The following are the minimum annual lease payments due under these leases at September 30, 2013:
 
Operating Leases
 
Capital Leases
 
(in thousands)
Remainder of 2013
$
1,026

 
$
268

2014
3,693

 
815

2015
2,676

 

2016
1,850

 

2017
1,623

 

2018 and thereafter
295

 

Total minimum lease payments
$
11,163

 
1,083

Less amount representing interest
 
 
(12
)
Present value of minimum payments
 
 
1,071

Less current portion
 
 
(1,071
)
Capital lease obligations, noncurrent
 
 
$


Rent expense was $1.3 million and $1.1 million for the three months ended September 30, 2013 and 2012, respectively, and $4.0 million and $3.1 million for the nine months ended September 30, 2013 and 2012, respectively. Although certain of the operating lease agreements provide for escalating rent payments over the terms of the leases, rent expense under these agreements is recognized on a straight-line basis. As of September 30, 2013 and December 31, 2012, the Company has accrued $0.5 million of deferred rent related to these agreements, which is reflected in other noncurrent liabilities in the accompanying condensed consolidated balance sheets.


15

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

Sales and Other Taxes
The Company’s software-as-a-service solutions are subject to sales and other taxes in certain jurisdictions where the Company does business. The Company bills sales and other taxes to customers and remits these amounts to the respective government authorities. For those jurisdictions where the Company has not yet billed sales tax to its customers and believes it is probable it may have exposure and can reasonably estimate such exposure, it has recorded a liability of $0.4 million at September 30, 2013 and December 31, 2012, which is recorded within accrued liabilities in the condensed consolidated balance sheets. However, taxing jurisdictions have differing rules and regulations, which are subject to varying interpretations that may change over time. Other than the liability that the Company has accrued in its condensed consolidated balance sheets, the Company has been unable to assess the probability, or estimate the amount, of its sales tax exposure, if any. There are no pending reviews at September 30, 2013 of which the outcome is expected to result in sales and other taxes due in excess of accrued liabilities. Management does not anticipate that its sales tax exposure, if any, would have a material adverse effect on the financial position, results of operations or cash flows of the Company.
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.

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

Contingencies
From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a liability for such matters when it is probable a loss has been incurred and such loss can be reasonably estimated. At September 30, 2013, other than an accrual for sales and other taxes, the Company has not recorded any material liabilities in accordance with accounting for contingencies.

16

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

NOTE 6.
Stock-based Compensation

Stock Options

2012 Equity Incentive Plan

The 2012 Equity Incentive Plan (the "2012 Plan") was adopted and approved in September 2012 and became effective on September 26, 2012. Under the 2012 Plan, the Company is authorized to grant to eligible participants incentive stock options (“ISOs”), nonstatutory stock options (“NSOs”), stock appreciation rights ("SARs"), restricted stock awards ("RSAs"), restricted stock units ("RSUs"), performance units and performance shares equivalent to up to 3,050,000 shares of common stock. The number of shares of common stock available for issuance under the 2012 Plan includes an annual increase on January 1 of each year starting on January 1, 2014 by an amount equal to the least of 3,050,000 shares; 5% of the outstanding shares of stock as of the last day of the immediately preceding fiscal year; or an amount determined by the board of directors. 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. Options granted generally vest over a period of up to four years, with a maximum term of ten years. ISOs may only be granted to employees and any subsidiary corporations' employees. All other awards may be granted to employees, directors and consultants and subsidiary corporations' employees and consultants. Options, SARs, RSAs, RSUs, performance units and performance awards may be granted with vesting terms as determined by the board of directors and expire no more than ten years after the date of grant or earlier if employment or service is terminated. As of September 30, 2013, 1,613,525 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 ISOs were granted at a price per share not less than the fair market value at the date of grant. The NSOs were granted at a price per share not less than 85% of the fair market value at the date of grant. Options granted generally vest over a period of up to four years, with a maximum term of ten years. The 2000 Plan was terminated in connection with the closing of the initial public offering ("IPO"), and accordingly, no shares are currently available for issuance under the 2000 Plan. The 2000 Plan continues to govern outstanding awards granted thereunder.

Options granted under the 2000 Plan were immediately exercisable, and unvested shares are subject to repurchase by the Company. Upon termination of employment of an option holder, the Company has the right to repurchase at the original purchase price any issued but unvested common shares. As of September 30, 2013 and December 31, 2012, there were 20,336 and 47,220 shares, respectively, that were subject to the Company’s right to repurchase. The Company repurchased 125 unvested common shares in the three and nine months ended September 30, 2013. There were no shares repurchased during the three months ended September 30, 2012. For the nine months ended September 30, 2012, the Company repurchased 60,125 unvested common shares. The amounts paid for these shares purchased under an early exercise of stock options are not reported as a component of stockholders’ equity until those shares vest. The amounts received in exchange for these shares totaled $0.1 million and $0.3 million as of September 30, 2013 and December 31, 2012, respectively, have been recorded as an accrued liability in the accompanying condensed consolidated balance sheets and will be reclassified to common stock and additional paid-in capital as the shares vest.


17

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

Employee Stock-based Compensation

Employee stock-based compensation is included in the condensed consolidated statements of operations as follows:

 
Three Months Ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Cost of revenues
$
103

 
$
68

 
$
297

 
$
191

Research and development
253

 
167

 
687

 
461

Sales and marketing
363

 
306

 
804

 
746

General and administrative
507

 
244

 
1,299

 
723

Total stock-based employee compensation
$
1,226

 
$
785

 
$
3,087

 
$
2,121


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.

As of September 30, 2013 and December 31, 2012, the Company had $8.7 million and $5.8 million, respectively, of total unrecognized employee compensation cost related to nonvested awards that it expects to recognize over a weighted-average period of 2 years.

The fair value of each option granted to employees is estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions:

 
Three Months Ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Expected term (in years)
5.4 to 6.1
 
5.3 to 6.0
 
5.4 to 6.1
 
5.3 to 6.0
Volatility
52% to 53%
 
53%
 
52% to 53%
 
53%
Risk-free interest rate
1.4% to 1.5%
 
0.6% to 0.7%
 
0.7% to 1.5%
 
0.6% to 0.8%
Dividend yield
 
 
 

The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected term at the grant date. Volatility is based on historical volatility of several public entities that are similar to the Company, as the Company does not have sufficient historical transactions in its own shares on which to base expected volatility. The Company has not historically issued any dividends and does not expect to in the future.


18

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

Non-Employee Stock-based Compensation

The Company records compensation representing the fair value of stock options granted to non-employees. Non-employee stock-based compensation was $0.4 million and $0.2 million for the three months ended September 30, 2013 and 2012, respectively, and $0.7 million and $0.4 million for the nine months ended September 30, 2013 and 2012, respectively. Non-employee stock-based compensation is recognized over the vesting periods of the options. The value of options granted to non-employees is remeasured as they vest over a performance period.

Stock Option Plan Activity

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

 
Outstanding Shares
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Life (Years)
 
Aggregate Intrinsic Value
 
 
 
 
 
 
 
(in thousands)
Balance as of December 31, 2012
6,513,508

 
$
4.39

 
6.6
 
$
67,711

Granted
1,412,325

 
13.34

 
 
 
 
Exercised
(816,166
)
 
4.13

 
 
 
 
Canceled
(339,713
)
 
9.07

 
 
 
 
Balance as of September 30, 2013
6,769,954

 
6.06

 
6.5
 
103,805

Vested and expected to vest - September 30, 2013
6,109,405

 
5.53

 
6.3
 
96,911

Exercisable - September 30, 2013
5,406,675

 
4.19

 
5.7
 
82,897


Restricted Stock

The terms and conditions of RSAs, including vesting criteria and timing are set by the board of directors. The cost of RSAs is determined using the fair value of the Company’s common stock on the date of the grant. Compensation cost is recognized on a straight-line basis over the requisite service period of each grant adjusted for estimated forfeitures. Recipients of RSAs generally have voting and dividend rights without regard to vesting. The Company has the right to repurchase shares that do not vest.

During the nine months ended September 30, 2013 and 2012, the Company granted 1,900 and 2,750 shares of restricted stock, respectively, which vested immediately and had no further restrictions or service period, and resulted in compensation expense of $20,000 and $32,000 for the nine months ended September 30, 2013 and 2012, respectively.


NOTE 7.
Other Income (Expense), Net

Other income (expense), net consists of the following:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Foreign exchange gains (losses), net
$
(60
)
 
$
52

 
$
(474
)
 
$
(42
)
Other income (expense)
(24
)
 
8

 
104

 
(2
)
Other income (expense), net
$
(84
)
 
$
60

 
$
(370
)
 
$
(44
)


19

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

NOTE 8.
Income Taxes

The provision for income taxes for the nine months ended September 30, 2013 and 2012 primarily reflects the provision for income taxes for foreign and state taxes and certain discrete items.

As of September 30, 2013, the Company had unrecognized tax benefits of $3.1 million, of which $0.9 million, if recognized and in absence of a valuation allowance, would favorably impact the Company's effective tax rate. As of December 31, 2012, the Company had unrecognized tax benefits of $2.6 million, of which $1.0 million, if recognized and in absence of valuation allowance, would favorably impact the Company's effective tax rate.


NOTE 9.
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:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
United States
$
19,943

 
$
16,063

 
$
55,750

 
$
45,644

Other
7,806

 
7,319

 
23,173

 
21,119

Total revenues
$
27,749

 
$
23,382

 
$
78,923

 
$
66,763


As of September 30, 2013 and December 31, 2012, property and equipment located outside the United States were not material.


20

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

NOTE 10.
Net Income Per Share Attributable to Common Stockholders

The computations for basic and diluted net income per share attributable to common stockholders are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Numerator:
 
 
 
 
 
 
 
Net income
$
1,309

 
$
1,667

 
$
1,579

 
$
1,105

Net income attributable to participating securities
(2
)
 
(1,252
)
 
(2
)
 
(841
)
Net income attributable to common stockholders - basic
1,307

 
415

 
1,577

 
264

Undistributed earnings reallocated to participating securities
1

 
1,249

 

 
839

Net income attributable to common stockholders - diluted
$
1,308

 
$
1,664

 
$
1,577

 
$
1,103

Denominator:
 
 
 
 
 
 
 
Weighted-average shares used in computing net income per share attributable to common stockholders - basic
32,088

 
5,843

 
31,789

 
5,540

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Convertible preferred stock

 
17,597

 

 
17,597

Common stock options
4,159

 
3,105

 
3,915

 
2,829

Contingently issuable shares related to an acquisition

 

 

 
6

Weighted-average shares used in computing net income per share attributable to common stockholders - diluted
36,247

 
26,545

 
35,704

 
25,972

Net income per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.04

 
$
0.07

 
$
0.05

 
$
0.05

Diluted
$
0.04

 
$
0.06

 
$
0.04

 
$
0.04


All of the convertible preferred stock automatically converted to common stock on a 1-for-1 basis in connection with the consummation of the Company's initial public offering. For the three and nine months ended September 30, 2012, the amounts presented in the table above were the weighted average shares of common stock underlying outstanding shares of convertible preferred stock.

The following shares were excluded in the calculation of diluted net income per share because their inclusion would have been anti-dilutive:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Common stock options
394

 
1,108

 
956

 
1,031

 
394

 
1,108

 
956

 
1,031




21

Table of Contents
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, 2012, filed with the Securities and Exchange Commission, or SEC, on March 5, 2013.
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. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
    
Overview

We are a pioneer and leading provider of cloud 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. 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 QualysGuard 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 QualysGuard Cloud Platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures.

We were founded 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, QualysGuard Vulnerability Management, in 2000. This solution has provided the substantial majority of our revenues to date, representing 84% and 87% for the nine months ended September 30, 2013 and 2012, respectively. As this solution gained acceptance, we introduced new solutions to help customers manage increasing IT security and compliance requirements. In 2006, we added our PCI Compliance solution, and in 2008, we added our Policy Compliance solution. In 2009, we broadened the scope of our cloud services by adding Web Application Scanning. We continued our expansion in 2010, launching Malware Detection Service and Qualys SECURE Seal for automated protection of websites. In 2012, we introduced our virtualized private cloud platform as an additional deployment option of our solutions for customers and partners.

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. Historically, we have experienced significant revenue growth from existing customers as they renew and purchase additional subscriptions.

We market and sell our solutions to enterprises, government entities and to small and medium size businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities. In the nine months ended September 30, 2013 and 2012, approximately 71% and 68%, respectively, of our revenues were derived from customers in the United States. We sell our solutions to enterprises and government entities primarily through our field sales force and to small and medium-sized businesses through our inside sales force. We generate a significant portion of sales through our channel partners, including managed service providers, value-added resellers and consulting firms in the United States and internationally.


22

Table of Contents

We have had continued revenue growth in the three and nine months ended September 30, 2013 compared to the same periods in 2012. Our revenues increased to $27.7 million in the three months ended September 30, 2013 from $23.4 million for the comparable period in 2012, representing an increase of $4.4 million or 19%. Revenues reached $78.9 million for the nine months ended September 30, 2013, compared to $66.8 million in the nine months ended September 30, 2012, representing an increase of $12.2 million, or 18%.

Key Metrics

In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies.
Four-Quarter Bookings
We monitor Four-Quarter Bookings, a non-GAAP financial measure, which is calculated as revenues for the preceding four quarters plus the change in current deferred revenues for the same period. We believe this metric provides an additional tool for investors to use in assessing our business performance in a way that more fully reflects current business trends than reported revenues and reduces the variations in any particular quarter caused by customer subscription renewals. We believe Four-Quarter Bookings reflects the material sales trends for our business because it includes sales of subscriptions to new customers, as well as subscription renewals and upsells of additional subscriptions to existing customers. Since over 80% of our subscriptions are one year in length, we use current deferred revenues in this metric in order to focus on revenues to be generated over the next four quarters and to exclude the impact of multi-year subscriptions. Under our revenue recognition policy, we record subscription fees as deferred revenues and recognize revenues ratably over the subscription periods. For this reason, substantially all of our revenues for a period are typically generated from subscriptions commencing in prior periods. In addition, subscription renewals may vary during the year based on the date of our customers’ original subscriptions, customer requests to modify subscription periods or other factors.

The following unaudited table presents the reconciliation of revenues to Four-Quarter Bookings for the four quarters ended September 30, 2013 and 2012:
 
Four Quarters Ended
 
September 30,
 
2013
 
2012
 
(in thousands, except percentages)
Revenues
$
103,580

 
$
87,416

Deferred revenues, current
 
 
 
Beginning of the Four-Quarter Period
51,693

 
40,413

Ending
61,389

 
51,693

Net change
9,696

 
11,280

Four-Quarter Bookings
$
113,276

 
$
98,696

Percentage change from prior year period
15
%
 
25
%


23

Table of Contents

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 income taxes, (3) depreciation and amortization of property and equipment, (4) amortization of intangible assets and (5) stock-based compensation.

The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for the three and nine months ended September 30, 2013 and 2012:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 (in thousands, except percentages)
Net income
$
1,309

 
$
1,667

 
$
1,579

 
$
1,105

Other (income) expense, net
(24
)
 
(23
)
 
134

 
195

Provision for income taxes
210

 
77

 
372

 
77

Depreciation and amortization of property and equipment
2,452

 
1,739

 
6,731

 
5,066

Amortization of intangible assets
105

 
112

 
319

 
331

Stock-based compensation
1,621

 
1,027

 
3,808

 
2,583

Adjusted EBITDA
$
5,673

 
$
4,599

 
$
12,943

 
$
9,357

Percentage of revenues
20
%
 
20
%
 
16
%
 
14
%


24

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Limitations of Four-Quarter Bookings and Adjusted EBITDA
Four-Quarter Bookings and Adjusted EBITDA, non-GAAP financial measures, have limitations as analytical tools, 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:

Four-Quarter Bookings reflects the amount of revenues over a four-quarter period, plus the net change in the current portion of deferred revenues, while revenues are recognized ratably over the subscription periods;
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 Four-Quarter Bookings or Adjusted EBITDA differently or not at all, which reduces their usefulness as a comparative measure.

Because of these limitations, Four-Quarter Bookings and Adjusted EBITDA should be considered alongside other financial performance measures, including revenues, net income and our financial results presented in accordance with U.S. GAAP.



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Table of Contents

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. We generate the substantial majority of our revenues through the sale of subscriptions to our QualysGuard Vulnerability Management solution, and we also have a growing number of customers who have purchased our additional solutions. Subscriptions to our solutions allow customers to access our cloud 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 networked 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. Customers are required to return physical scanner appliances 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 sheet as accounts receivable or as cash when collected, and as deferred revenues until earned and recognized ratably over the subscription period. Accordingly, deferred revenues represents 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 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, shipping costs, fees paid to contractors who supplement or support our operations center personnel and overhead allocations. We expect to continue to make significant capital investments to expand 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 prior 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 expect that research and development expenses will increase in absolute dollars.


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Table of Contents


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 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 and the rate at which they generate incremental revenues may affect our future operating results. We expect that sales and marketing expenses will increase 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, human resources and internal information technology support teams, professional services fees, insurance, certain other corporate governance-related expenses, and overhead allocations. We expect that general and administrative expenses will increase in absolute dollars, as we continue to add personnel to support our growth and operate as a public company.


Other Income (Expense), Net
Our other income (expense), net consists primarily of foreign exchange gains and losses, the majority of which result from fluctuations between the U.S. dollar and the Euro, British pound and Japanese yen, interest expense associated with our capital leases, and interest and investment income.

Provision for Income Taxes
Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by wholly-owned subsidiaries, along with state income taxes payable in the United States. The provision for income taxes also includes changes to unrecognized tax benefits related to uncertain tax positions.

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 maintain a valuation allowance on our U.S. federal and state deferred tax assets. Our cash tax expense is impacted by each jurisdiction’s individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits. Given the valuation allowance and sensitivity of current cash taxes to local rules, our effective tax rate could fluctuate significantly on a quarterly basis, to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. Our effective tax rate could also change due to changes in our earnings projections, by changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, or accounting principles, as well as certain discrete items.


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Table of Contents

Results of Operations
The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenues
$
27,749

 
$
23,382

 
$
78,923

 
$
66,763

Cost of revenues (1)
6,415

 
4,634

 
18,134

 
13,423

Gross profit
21,334

 
18,748

 
60,789

 
53,340

Operating expenses:
 
 
 
 
 
 
 
Research and development (1)
5,151

 
5,076

 
15,739

 
15,325

Sales and marketing (1)
10,411

 
8,797

 
30,739

 
27,827

General and administrative (1)
4,277

 
3,154

 
12,226

 
8,811

Total operating expenses
19,839

 
17,027

 
58,704

 
51,963

Income from operations
1,495

 
1,721

 
2,085


1,377

Other income (expense), net
24

 
23

 
(134
)
 
(195
)
Income before provision for income taxes
1,519

 
1,744

 
1,951

 
1,182

Provision for income taxes
210

 
77

 
372

 
77

Net income
$
1,309

 
$
1,667

 
$
1,579

 
$
1,105




____________________
(1) Includes stock-based compensation as follows:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Cost of revenues
$
103

 
$
68

 
$
307

 
$
195

Research and development
253

 
167

 
697

 
484

Sales and marketing
363

 
349

 
804

 
856

General and administrative
902

 
443

 
2,000

 
1,048

Total stock-based compensation
$
1,621

 
$
1,027

 
$
3,808

 
$
2,583



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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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Revenues
100
%
 
100
%
 
100
 %
 
100
 %
Cost of revenues
23

 
20

 
23

 
20

Gross profit
77

 
80


77


80

Operating expenses:
 
 
 
 
 
 
 
Research and development
19

 
22

 
20

 
23

Sales and marketing
38

 
38

 
39

 
42

General and administrative
15

 
13

 
15

 
13

Total operating expenses
72

 
73


74


78

Income from operations
5

 
7


3


2

Other income (expense), net

 

 

 

Income before provision for income taxes
5

 
7


3


2

Provision for income taxes

 

 
1

 

Net income
5
%
 
7
%

2
 %

2
 %

Comparison of Three Months Ended September 30, 2013 and 2012
Revenues
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Revenues
$
27,749

 
$
23,382

 
$
4,367

 
19
%

Revenues increased $4.4 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012, primarily due to new customer subscriptions entered into after September 30, 2012 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $4.4 million, $3.9 million was from customers in the United States and the remaining $0.5 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions.


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Table of Contents

Cost of Revenues
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Cost of revenues
$
6,415

 
$
4,634

 
$
1,781

 
38
%
Percentage of revenues
23
%
 
20
%
 
 
 
 
Gross profit percentage
77
%
 
80
%
 
 
 
 
Cost of revenues increased $1.8 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012, primarily due to a $0.7 million increase in depreciation expenses related to additional computer hardware and software for our new and existing data centers, increased personnel expenses of $0.4 million, principally driven by the addition of employees in our operations staff, increased data center cost of $0.3 million related to expanded storage and other data center-related costs, and increased third-party software maintenance expense of $0.3 million. The decrease in gross profit percentage reflects the impact of continued increased investments to expand our data center infrastructure, to further enable disaster recovery of our solutions, and to add capacity to deploy new solutions on our cloud platform.

Research and Development Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Research and development
$
5,151

 
$
5,076

 
$
75

 
1
%
Percentage of revenues
19
%
 
22
%
 
 
 
 

Research and development expenses remained relatively constant in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, with slight increases in personnel expenses as we continue to invest in enhancing our platform and developing new solutions.

Sales and Marketing Expenses

 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Sales and marketing
$
10,411

 
$
8,797

 
$
1,614

 
18
%
Percentage of revenues
38
%
 
38
%
 
 
 
 

Sales and marketing expenses increased $1.6 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012, primarily due to an increase in personnel expenses of $0.6 million, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts and increased recruiting expenses of $0.2 million. We also incurred increased marketing expenses of $0.5 million, primarily related to increased trade show and program activities, and travel related costs of $0.1 million.


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Table of Contents

General and Administrative Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
General and administrative
$
4,277

 
$
3,154

 
$
1,123

 
36
%
Percentage of revenues
15
%
 
13
%
 
 
 
 

General and administrative expenses increased $1.1 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012, primarily driven by increased personnel expenses of $0.5 million principally due to the addition of employees to support the growth of our business and building out of our infrastructure to support public company requirements. We also incurred increased stock-based compensation of $0.2 million related to non-employees, primarily due to relatively higher stock prices, as well as increased insurance, director fees and other fees of $0.2 million, and increased professional services of $0.1 million.

Other Income (Expense), Net
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Other income (expense), net
$
24

 
$
23

 
$
1

 
4
%
Percentage of revenues
%
 
%
 
 
 
 

Other income (expense), net was relatively constant for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Other income (expense) for the three months ended September 30, 2013 included foreign exchange losses of $0.1 million, offset by $0.1 million of investment income.

Provision for Income Taxes
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Provision for income taxes
$
210

 
$
77

 
$
133

 
173
%
Percentage of revenues
1
%
 
%
 
 
 
 

Provision for income taxes increased $0.1 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. The provision for income taxes is primarily for taxes on income in foreign jurisdictions and state income taxes in the United States. The increase is primarily due to a higher reduction of the liability for uncertain tax positions related to foreign taxes in the three months ended September 30, 2012.

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Comparison of Nine Months Ended September 30, 2013 and 2012
Revenues
 
Nine Months Ended
 
 
 
 
 
September 30,
 
Change
 
2013
 
2012
 
$
 
%
 
(in thousands, except percentages)
Revenues
$
78,923

 
$
66,763

 
$
12,160

 
18
%

Revenues increased $12.2 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012 primarily due to new customer subscriptions entered into after September 30, 2012 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $12.2 million, $10.1 million was from customers in the United States and the remaining $2.1 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions.

Cost of Revenues
 
Nine Months Ended
 
 
 
 
 
September 30,