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QLYS-2014 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, 2014

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, 2014 was 33,320,475.

Table of Contents

Qualys, Inc.
TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
Item 1.
 
 
Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013
 
 
 
 
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, 2014
 
December 31, 2013
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
88,285

 
$
42,369

Short-term investments
25,133

 
54,827

Accounts receivable, net of allowance of $543 and $389 at September 30, 2014 and December 31, 2013, respectively
30,278

 
28,581

Prepaid expenses and other current assets
5,901

 
4,679

Total current assets
149,597

 
130,456

Long-term investments
37,896

 
35,608

Property and equipment, net
24,776

 
23,075

Intangible assets, net
2,099

 
2,394

Goodwill
317

 
317

Other noncurrent assets
726

 
753

Total assets
$
215,411

 
$
192,603

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,898

 
$
1,930

Accrued liabilities
9,101

 
9,037

Deferred revenues, current
74,337

 
67,505

Capital lease obligations, current
—

 
805

Total current liabilities
85,336

 
79,277

Deferred revenues, noncurrent
8,965

 
8,889

Other noncurrent liabilities
1,417

 
1,320

Total liabilities
95,718

 
89,486

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, 2014 and December 31, 2013
—

 
—

Common stock, $0.001 par value; 1,000,000,000 shares authorized, 33,263,309 and 32,375,299 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
33

 
32

Additional paid-in capital
188,923

 
176,641

Accumulated other comprehensive loss
(1,269
)
 
(1,088
)
Accumulated deficit
(67,994
)
 
(72,468
)
Total stockholders’ equity
119,693

 
103,117

Total liabilities and stockholders’ equity
$
215,411

 
$
192,603


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,
 
2014
 
2013
 
2014
 
2013
Revenues
$
34,348

 
$
27,749

 
$
97,006

 
$
78,923

Cost of revenues
7,421

 
6,415

 
21,442

 
18,134

Gross profit
26,927

 
21,334

 
75,564

 
60,789

Operating expenses:
 
 
 
 
 
 
 
Research and development
6,490

 
5,151

 
19,305

 
15,739

Sales and marketing
11,774

 
10,411

 
36,111

 
30,739

General and administrative
5,156

 
4,277

 
15,112

 
12,226

Total operating expenses
23,420

 
19,839

 
70,528

 
58,704

Income from operations
3,507

 
1,495

 
5,036

 
2,085

Other income (expense), net:
 
 
 
 
 
 
 
Interest expense
(2
)
 
(7
)
 
(9
)
 
(37
)
Interest income
127

 
115

 
365

 
273

Other income (expense), net
(141
)
 
(84
)
 
(279
)
 
(370
)
Total other income (expense), net
(16
)
 
24

 
77

 
(134
)
Income before provision for income taxes
3,491

 
1,519

 
5,113

 
1,951

Provision for income taxes
283

 
210

 
639

 
372

Net income
$
3,208

 
$
1,309

 
$
4,474

 
$
1,579

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.04

 
$
0.14

 
$
0.05

Diluted
$
0.09

 
$
0.04

 
$
0.12

 
$
0.04

Weighted average shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
33,120

 
32,088

 
32,820

 
31,789

Diluted
37,080

 
36,247

 
37,006

 
35,704


See accompanying Notes to Condensed Consolidated Financial Statements


4
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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,
 
2014
 
2013
 
2014
 
2013
Net income
$
3,208

 
$
1,309

 
$
4,474

 
$
1,579

Change in foreign currency translation loss, net of zero tax
(101
)
 
(12
)
 
(142
)
 
(73
)
Available-for-sale investments:
 
 
 
 
 
 
 
Change in net unrealized gain (loss) on investments, net of zero tax
(44
)
 
52

 
(11
)
 
37

Less: reclassification adjustment for net realized gain included in net income
(27
)
 
(1
)
 
(28
)
 
(9
)
Net change, net of zero tax
(71
)
 
51

 
(39
)
 
28

Other comprehensive income (loss), net
(172
)
 
39

 
(181
)
 
(45
)
Comprehensive income
$
3,036

 
$
1,348

 
$
4,293

 
$
1,534


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,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
4,474

 
$
1,579

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
8,826

 
7,050

Bad debt expense
346

 
211

Loss on disposal of property and equipment
1

 
12

Stock-based compensation
7,100

 
3,808

Amortization of premiums and accretion of discounts on investments
427

 
188

Excess tax benefits from stock-based compensation
(131
)
 
(59
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(2,042
)
 
(688
)
Prepaid expenses and other assets
(1,238
)
 
229

Accounts payable
(48
)
 
(939
)
Accrued liabilities
364

 
(549
)
Deferred revenues
6,907

 
4,732

Other noncurrent liabilities
99

 
(383
)
Net cash provided by operating activities
25,085

 
15,191

Cash flows from investing activities:
 
 
 
Purchases of investments
(117,279
)
 
(113,689
)
Sales and maturities of investments
144,218

 
113,524

Purchases of property and equipment
(10,252
)
 
(10,364
)
Release of restricted cash
—

 
114

Net cash provided by (used in) investing activities
16,687

 
(10,415
)
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
5,046

 
3,374

Excess tax benefits from stock-based compensation
131

 
59

Principal payments under capital lease obligations
(805
)
 
(920
)
Net cash provided by financing activities
4,372

 
2,513

Effect of exchange rate changes on cash and cash equivalents
(228
)
 
(56
)
Net increase in cash and cash equivalents
45,916

 
7,233

Cash and cash equivalents at beginning of period
42,369

 
34,885

Cash and cash equivalents at end of period
$
88,285

 
$
42,118

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

 
$
731

Vesting of early exercised common stock options
$
41

 
$
204


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, 2013, 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, 2014 is not necessarily indicative of the results of operations expected for the entire year ending December 31, 2014 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, 2013 filed with the SEC on February 28, 2014.

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, stock-based compensation and the valuation allowances associated with deferred tax assets.


7
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

Actual results could differ from those estimates and such differences may be material to the accompanying condensed consolidated financial statements.


Concentration of Credit Risk

The Company invests its cash and cash equivalents with major financial institutions. Cash balances with any one institution at times may be in excess of federally insured limits. Cash equivalents are invested in high-quality investment grade financial instruments and are diversified. The Company has not experienced any 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, 2014 and December 31, 2013, 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, municipal bonds, corporate 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 equivalents are stated at cost, which approximates fair market value. 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.

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 May 2014, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standard Update (“ASU”) amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising


8
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

from contracts with customers. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016, with early adoption prohibited. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements.

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 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.

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 and liabilities 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, such as quotations on forward foreign exchange points and foreign interest rates.


9
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


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

 
 
September 30, 2014
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
35,750

 
$
—

 
$
—

 
$
35,750

Money market funds
 
28,536

 
—

 
—

 
28,536

U.S. government agencies
 
15,724

 
1

 
—

 
15,725

Commercial paper
 
7,199

 
—

 
—

 
7,199

Corporate bonds
 
1,075

 
—

 
—

 
1,075

Total
 
88,284

 
1

 
—

 
88,285

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
4,991

 
4

 
—

 
4,995

Corporate bonds
 
12,126

 
16

 
—

 
12,142

U.S. government agencies
 
7,996

 
—

 
—

 
7,996

Total
 
25,113

 
20

 
—

 
25,133

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
18,260

 
11

 
(1
)
 
18,270

Corporate bonds
 
1,801

 
—

 
(2
)
 
1,799

U.S. government agencies
 
17,857

 
—

 
(30
)
 
17,827

Total
 
37,918

 
11

 
(33
)
 
37,896

Total
 
$
151,315

 
$
32

 
$
(33
)
 
$
151,314




10
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

 
 
December 31, 2013
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
27,488

 
$
—

 
$
—

 
$
27,488

Money market funds
 
183

 
—

 
—

 
183

Commercial paper
 
14,697

 
1

 
—

 
14,698

Total
 
42,368

 
1

 
—

 
42,369

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
32,784

 
6

 
—

 
32,790

Corporate bonds
 
16,894

 
11

 
—

 
16,905

Municipal bonds
 
1,128

 
—

 
—

 
1,128

U.S. government agencies
 
4,004

 
—

 
—

 
4,004

Total
 
54,810

 
17

 
—

 
54,827

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
5,497

 
4

 
—

 
5,501

Corporate bonds
 
15,256

 
22

 
(4
)
 
15,274

U.S. government agencies
 
14,835

 
1

 
(3
)
 
14,833

Total
 
35,588

 
27

 
(7
)
 
35,608

Total
 
$
132,766

 
$
45

 
$
(7
)
 
$
132,804



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, 2014
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
—

 
$
12,194

 
$
—

 
$
12,194

Asset-backed securities
 
—

 
18,270

 
—

 
18,270

Corporate bonds
 
—

 
15,016

 
—

 
15,016

U.S. government agencies
 
—

 
41,548

 
—

 
41,548

Total
 
$
—

 
$
87,028

 
$
—

 
$
87,028


 
 
December 31, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
—

 
$
47,488

 
$
—

 
$
47,488

Asset-backed securities
 
—

 
5,501

 
—

 
5,501

Corporate bonds
 
—

 
32,179

 
—

 
32,179

Municipal bonds
 
—

 
1,128

 
—

 
1,128

U.S. government agencies
 
—

 
18,837

 
—

 
18,837

Total
 
$
—

 
$
105,133

 
$
—

 
$
105,133




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, 2014
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
12,194

 
$
—

 
$
—

 
$
12,194

Corporate bonds
 
13,217

 
1,799

 
—

 
15,016

U.S. government agencies
 
23,721

 
17,827

 
—

 
41,548

Asset-backed securities
 
—

 
8,806

 
9,464

 
18,270

Total
 
$
49,132

 
$
28,432

 
$
9,464

 
$
87,028

 
 
December 31, 2013
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
47,488

 
$
—

 
$
—

 
$
47,488

Municipal bonds
 
1,128

 
—

 
—

 
1,128

Corporate bonds
 
16,905

 
15,274

 
—

 
32,179

U.S. government agencies
 
4,004

 
14,833

 
—

 
18,837

Asset-backed securities
 
—

 
—

 
5,501

 
5,501

Total
 
$
69,525

 
$
30,107

 
$
5,501

 
$
105,133

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

At September 30, 2014, the Company had two outstanding forward contracts with notional amounts of 4.1 million Euros and 2.1 million British Pounds, both of which expired on October 31, 2014. At December 31, 2013, the Company had two outstanding forward contracts with notional amounts of 6.3 million Euros and 2.0 million British Pounds, which expired on January 31, 2014. 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, 2014 and December 31, 2013. The Company recorded gains of $0.5 million and $0.4 million from forward contracts for the three and nine months ended September 30, 2014, respectively. These gains were more than offset by foreign currency transaction losses of $0.6 million and $0.6 million for the three and nine months ended September 30, 2014, respectively. The Company recorded losses of $0.4 million and $0.6 million from forward contracts in the three and nine months ended September 30, 2013, respectively. These losses 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. These derivatives did not meet the criteria to be designated as hedges. These instruments were valued using Level 2 inputs.

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


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,
 
2014
 
2013
 
(in thousands)
Computer equipment
$
33,764

 
$
27,464

Computer software
9,452

 
9,277

Furniture, fixtures and equipment
2,826

 
2,031

Scanner appliances
19,142

 
17,055

Leasehold improvements
2,337

 
2,100

Total property and equipment
67,521

 
57,927

Less: accumulated depreciation and amortization
(42,745
)
 
(34,852
)
Property and equipment, net
$
24,776

 
$
23,075


Assets held under capital lease included in computer software totaled approximately $3.1 million and the related accumulated depreciation totaled $1.2 million at December 31, 2013. These capital lease obligations were secured by the related software. There were no assets under capital lease at September 30, 2014.

Physical scanner appliances and other computer equipment that are or will be subject to subscriptions by customers have a net carrying value of $5.3 million and $4.7 million at September 30, 2014 and December 31, 2013, respectively, including assets that have not been placed in service of $0.9 million and $0.6 million, respectively. Other fixed assets not placed in service at September 30, 2014 and December 31, 2013, included in computer equipment and leasehold improvements, relate to new information technology systems and tenant improvements of approximately $2.2 million and $1.6 million, respectively. Depreciation and amortization expense relating to property and equipment, including capitalized leases, was $2.9 million and $2.4 million for three months ended September 30, 2014 and 2013, respectively, and $8.5 million and $6.7 million for the nine months ended September 30, 2014 and 2013, 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, 2014
 
December 31, 2013
 
Estimated Lives
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Accumulated Amortization
 
Net Book Value
Existing technology
7 years
 
$
1,910

 
$
(1,115
)
 
$
795

 
$
(909
)
 
$
1,001

Patent license
14 years
 
1,388

 
(397
)
 
991

 
(323
)
 
1,065

Non-competition agreements and other
3 years
 
171

 
(153
)
 
18

 
(138
)
 
33

     Total intangibles subject to amortization
 
 
$
3,469

 
$
(1,665
)
 
1,804

 
$
(1,370
)
 
2,099

Intangible assets not subject to amortization
 
 
 
 
 
 
295

 
 
 
295

     Total intangible assets, net
 
 
 
 
 
 
$
2,099

 
 
 
$
2,394


Intangibles amortization expense was $0.1 million for the three months ended September 30, 2014 and 2013 and $0.3 million for the nine months ended September 30, 2014 and 2013.

As of September 30, 2014, the Company expects amortization expense in future periods to be as follows (in thousands):
Remainder of 2014
$
98

2015
386

2016
373

2017
282

2018
100

2019 and thereafter
565

Total expected future amortization expense
$
1,804


Goodwill, which is not subject to amortization, totaled $0.3 million as of September 30, 2014 and December 31, 2013.



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 2024. There were no remaining capital lease obligations as of September 30, 2014.

The following are the minimum annual lease payments due under operating leases at September 30, 2014:
 
Operating Leases
 
(in thousands)
Remainder of 2014
$
1,049

2015
3,138

2016
2,142

2017
1,836

2018
437

2019 and thereafter
1,349

Total minimum lease payments
$
9,951


Rent expense was $1.6 million and $1.3 million for the three months ended September 30, 2014 and 2013, respectively, and $4.6 million and $4.0 million for the nine months ended September 30, 2014 and 2013, 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, 2014 and December 31, 2013, the Company has accrued $0.6 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 $0.5 million at September 30, 2014 and December 31, 2013, 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, 2014 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, 2014, 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

Under the 2012 Equity Incentive Plan (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 4,668,764 shares of common stock. Options may be granted with an exercise price that is at least equal to the fair market value of the Company's stock at the date of grant and are exercisable when vested. As of September 30, 2014, 1,635,176 shares were available for grant under the 2012 Plan.

2000 Equity Incentive Plan

Under the 2000 Equity Incentive Plan (the "2000 Plan"), the Company was authorized to grant to eligible participants either ISOs or NSOs. The 2000 Plan was terminated in connection with the closing of the 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.

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,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Cost of revenues
$
175

 
$
103

 
$
482

 
$
297

Research and development
599

 
253

 
1,544

 
687

Sales and marketing
561

 
363

 
1,839

 
804

General and administrative
1,050

 
507

 
2,815

 
1,299

Total employee stock-based compensation
$
2,385

 
$
1,226

 
$
6,680

 
$
3,087


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, 2014, the Company had $19.6 million of total unrecognized employee compensation cost related to nonvested awards that it expects to recognize over a weighted-average period of 2.4 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,
 
2014
 
2013
 
2014
 
2013
Expected term (in years)
5.3 to 5.9
 
5.4 to 6.1
 
5.3 to 5.9
 
5.4 to 6.1
Volatility
48% to 50%
 
52% to 53%
 
48% to 52%
 
52% to 53%
Risk-free interest rate
1.67%
 
1.4% to 1.5%
 
1.52% to 1.67%
 
0.7% to 1.5%
Dividend yield
—
 
—
 
—
 
—



17
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

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.

Non-Employee Stock-based Compensation

The Company records compensation representing the fair value of stock options granted to non-employees. Stock-based non-employee compensation was $0.1 million and $0.4 million for the three months ended September 30, 2014 and 2013, respectively, and $0.4 million and $0.7 million for the nine months ended September 30, 2014 and 2013. 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, 2013
7,039,093

 
$
7.17

 
6.5
 
$
112,312

Granted
1,744,950

 
23.62

 
 
 
 
Exercised
(885,734
)
 
5.66

 
 
 
 
Canceled
(760,550
)
 
16.39

 
 
 
 
Balance as of September 30, 2014
7,137,759

 
10.40

 
6.3
 
115,840

Vested and expected to vest - September 30, 2014
6,671,173

 
9.76

 
6.1
 
112,540

Exercisable - September, 2014
4,692,121

 
4.93

 
5.1
 
101,700


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.

During the nine months ended September 30, 2014 and 2013, the Company granted 2,401 and 1,900 shares of restricted stock, respectively, which vested immediately and had no further restrictions or service period, and resulted in compensation expense of $51,000 and $20,000 for the nine months ended September 30, 2014 and 2013, respectively.


18
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


NOTE 7.
Accumulated Other Comprehensive Income (Loss)

The following table presents the components of accumulated other comprehensive income (loss):

 
 
September 30,
 
December 31,
 
 
2014
 
2013
 
 
(in thousands)
Foreign currency translation gain (loss), net of zero tax
 
$
(1,268
)
 
$
(1,126
)
Net unrealized gain (loss) on investments, net of zero tax
 
(1
)
 
38

Total
 
$
(1,269
)
 
$
(1,088
)


NOTE 8.
Other Income (Expense), Net

Other income (expense), net consists of the following:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Foreign exchange losses
$
(114
)
 
$
(60
)
 
$
(199
)
 
$
(474
)
Other income (expense)
(27
)
 
(24
)
 
(80
)
 
104

Other income (expense), net
$
(141
)
 
$
(84
)
 
$
(279
)
 
$
(370
)



19
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 9.
Income Taxes

The provision for income taxes for the nine months ended September 30, 2014 and 2013 primarily reflects foreign and state taxes, and certain discrete items.

As of September 30, 2014 and December 31, 2013, the Company had unrecognized tax benefits of $3.5 million and $3.3 million, respectively, of which $1.0 million, if recognized and in absence of a valuation allowance, would favorably impact the Company's effective tax rate.


NOTE 10.
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,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
United States
$
24,038

 
$
19,352

 
$
67,948

 
$
55,159

Other
10,310

 
8,397

 
29,058

 
23,764

Total revenues
$
34,348

 
$
27,749

 
$
97,006

 
$
78,923



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

 
September 30,
 
December 31,
 
2014
 
2013
 
(in thousands)
United States
$
22,013

 
$
19,909

Other
2,763

 
3,166

Total property and equipment, net
$
24,776

 
$
23,075




20
Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 11.
Net Income Per Share

The computations for basic and diluted net income per share are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Numerator:
 
 
 
 
 
 
 
Net income
$
3,208

 
$
1,309

 
$
4,474

 
$
1,579

Net income attributable to participating securities
—

 
(2
)
 
—

 
(2
)
Net income attributable to common stockholders - basic
3,208

 
1,307

 
4,474

 
1,577

Undistributed earnings reallocated to participating securities
—

 
1

 
—

 
—

Net income attributable to common stockholders - diluted
$
3,208

 
$
1,308

 
$
4,474

 
$
1,577

Denominator:
 
 
 
 
 
 
 
Weighted-average shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
33,120

 
32,088

 
32,820

 
31,789

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Common stock options
3,960

 
4,159

 
4,186

 
3,915

Diluted
37,080

 
36,247

 
37,006

 
35,704

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.04

 
$
0.14

 
$
0.05

Diluted
$
0.09

 
$
0.04

 
$
0.12

 
$
0.04


Potentially dilutive securities not included in the calculation of diluted net income per share because doing so would be antidilutive are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Common stock options
1,813

 
394

 
1,483

 
956





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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, 2013, filed with the Securities and Exchange Commission, or SEC, on February 28, 2014.
In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, it is possible to identify forward-looking statements because they contain words such as “anticipates,” “believes,” “contemplates,” “continue,” “could,” “estimates,” “expects,” “future,” “intends,” “likely,” “may,” “plans,” “potential,” “predicts,” “projects,” “seek,” “should,” “target,” or “will,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

•
our financial performance, including our revenues, costs, expenditures, growth rates, operating expenses and ability to generate positive cash flow to attain and sustain profitability;
•
anticipated technology trends, such as the use of cloud solutions;
•
our ability to adapt to changing market conditions;
•
economic and financial conditions, including volatility in foreign exchange rates;
•
our ability to diversify our sources of revenues;
•
the effects of increased competition in our market;
•
our ability to effectively manage our growth;
•
our anticipated investments in sales and marketing, our infrastructure, new solutions, and research and development;
•
maintaining and expanding our relationships with channel partners;
•
our ability to maintain, protect and enhance our brand and intellectual property;
•
costs associated with defending intellectual property infringement and other claims;
•
our ability to attract and retain qualified employees and key personnel;
•
our ability to successfully enter new markets and manage our international expansion; and
•
other factors discussed in this Quarterly Report on Form 10-Q in the sections titled “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations.”

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


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


22
Table of Contents

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 and incorporated in December 1999 with a vision of transforming the way organizations secure and protect their IT infrastructure and applications and initially launched our first cloud solution, QualysGuard Vulnerability Management, in 2000. This solution has provided the substantial majority of our revenues to date, representing 82% and 84% of total revenues for the nine months ended September 30, 2014 and 2013, 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. In 2014, we released a new Continuous Security Monitoring service for Internet-facing systems, which allows customers to continuously monitor their mission-critical assets and to be alerted to security vulnerabilities or misconfigurations that may make them susceptible to a cyber attack.

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

We market and sell our solutions to enterprises, government entities and to small and medium-sized businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities. In the nine month periods ended September 30, 2014 and 2013, approximately 70% 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.

We have had continued revenue growth in the nine months ended September 30, 2014 compared to the same period in 2013. Our revenues increased to $34.3 million in the three months ended September 30, 2014 from $27.7 million for the comparable period in 2013, representing an increase of $6.6 million or 24%. Revenues reached $97.0 million for the nine months ended September 30, 2014, compared to $78.9 million for the nine months ended September 30, 2013. For the three months ended September 30, 2014 and 2013, we had net income of $3.2 million and $1.3 million, respectively. For the nine months ended September 30, 2014 and 2013, we had net income of $4.5 million and $1.6 million, respectively.

Adjusted EBITDA

In addition to measures of financial performance presented in our condensed consolidated financial statements, 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)


23
Table of Contents

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, 2014 and 2013:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 (in thousands, except percentages)
Net income
$
3,208

 
$
1,309

 
$
4,474

 
$
1,579

Other (income) expense, net
16

 
(24
)
 
(77
)
 
134

Provision for income taxes
283

 
210

 
639

 
372

Depreciation and amortization of property and equipment
2,946

 
2,452

 
8,532

 
6,731

Amortization of intangible assets
98

 
105

 
294

 
319

Stock-based compensation
2,494

 
1,621

 
7,100

 
3,808

Adjusted EBITDA
$
9,045

 
$
5,673

 
$
20,962

 
$
12,943

Percentage of revenues
26
%
 
20
%
 
22
%
 
16
%

Limitations of Adjusted EBITDA
Adjusted EBITDA, a non-GAAP financial measure, has limitations as an analytical tool, and should not be considered in isolation from or as a substitute for the measures presented in accordance with U.S. GAAP. Some of these limitations are:
•
Adjusted EBITDA does not reflect certain cash and non-cash charges that are recurring;

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

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

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

Because of these limitations, 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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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 and computer hardware provided to certain customers as part of their subscriptions, expenses related to the use of third-party data centers, amortization of third-party technology licensing fees and related maintenance support, fees paid to contractors who supplement or support our operations center personnel and overhead allocations. We expect to continue to make capital investments to expand and support our data center operations, which will increase the cost of revenues in absolute dollars.

Operating Expenses
Research and Development

Research and development expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our research and development teams. Other expenses include third-party contractor fees, amortization of intangibles related to 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 capabilities 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 to continue to invest in additional sales personnel and more marketing programs as we introduce new solutions on our platform, which will increase sales and marketing expenses in absolute dollars.

General and Administrative

General and administrative expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our executive, finance and accounting, legal, human resources and internal information technology support teams, as well as professional services, insurance, fees, 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 and incur professional services to support our growth and compliance requirements.


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

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 net 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, and also 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,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenues
$
34,348

 
$
27,749

 
$
97,006

 
$
78,923

Cost of revenues (1)
7,421

 
6,415

 
21,442

 
18,134

Gross profit
26,927

 
21,334

 
75,564

 
60,789

Operating expenses:
 
 
 
 
 
 
 
Research and development (1)
6,490

 
5,151

 
19,305

 
15,739

Sales and marketing (1)
11,774

 
10,411

 
36,111

 
30,739

General and administrative (1)
5,156

 
4,277

 
15,112

 
12,226

Total operating expenses
23,420

 
19,839

 
70,528

 
58,704

Income from operations
3,507

 
1,495

 
5,036


2,085

Other income (expense), net
(16
)
 
24

 
77

 
(134
)
Income before provision for income taxes
3,491

 
1,519

 
5,113

 
1,951

Provision for income taxes
283

 
210

 
639

 
372

Net income
$
3,208

 
$
1,309

 
$
4,474

 
$
1,579




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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Cost of revenues
$
175

 
$
103

 
$
482

 
$
307

Research and development
599

 
253

 
1,551

 
697

Sales and marketing
561

 
363

 
1,852

 
804

General and administrative
1,159

 
902

 
3,215

 
2,000

Total stock-based compensation
$
2,494

 
$
1,621

 
$
7,100

 
$
3,808




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Table of Contents

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,
 
2014
 
2013
 
2014
 
2013
Revenues
100
 %
 
100
%
 
100
%
 
100
 %
Cost of revenues
22

 
23

 
22

 
23

Gross profit
78

 
77


78


77

Operating expenses:
 
 
 
 
 
 
 
Research and development
19

 
19

 
20

 
20

Sales and marketing
34

 
38

 
37

 
39

General and administrative
15

 
15

 
16

 
15

Total operating expenses
68

 
72


73


74

Income from operations
10

 
5


5


3

Other income (expense), net
0

 
0

 
0

 
0

Income before provision for income taxes
10

 
5


5


3

Provision for income taxes
1

 
0

 
1

 
1

Net income
9
 %
 
5
%

4
%

2
 %

Comparison of Three Months Ended September 30, 2014 and 2013
Revenues
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Revenues
$
34,348

 
$
27,749

 
$
6,599

 
24
%

Revenues increased $6.6 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to new customer subscriptions entered into after September 30, 2013 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $6.6 million, $4.7 million was from customers in the United States and the remaining $1.9 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
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Cost of revenues
$
7,421

 
$
6,415

 
$
1,006

 
16
%
Percentage of revenues
22
%
 
23
%
 
 
 
 
Gross profit percentage
78
%
 
77
%
 
 
 
 
Cost of revenues increased $1.0 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to a $0.4 million increase in depreciation expenses related to additional computer hardware and software for our new and existing data centers; increased consulting expenses of $0.3 million; increased third-party software maintenance expense of $0.1 million; as well as increased data center costs of $0.1 million, driven by expanded storage and other data center-related costs.

Research and Development Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Research and development
$
6,490

 
$
5,151

 
$
1,339

 
26
%
Percentage of revenues
19
%
 
19
%
 
 
 
 

Research and development expenses increased $1.3 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to an increase in personnel expenses of $1.1 million, including higher stock-based compensation, principally driven by the addition of employees as we continue to invest in enhancing our platform and developing new solutions and capabilities; and higher corporate overhead costs of $0.2 million, principally due to expansion of our research and development team in India

Sales and Marketing Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Sales and marketing
$
11,774

 
$
10,411

 
$
1,363

 
13
%
Percentage of revenues
34
%
 
38
%
 
 
 
 

Sales and marketing expenses increased $1.4 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to an increase in personnel expenses of $1.1 million, including higher commission expense and stock-based compensation, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts. We also incurred increased marketing expenses of $0.2 million, primarily related to increased trade show activities.



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Table of Contents

General and Administrative Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
General and administrative
$
5,156

 
$
4,277

 
$
879

 
21
%
Percentage of revenues
15
%
 
15
%
 
 
 
 

General and administrative expenses increased $0.9 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily driven by increased personnel expenses of $0.8 million, including higher employee stock-based compensation, principally due to the addition of employees to support the growth of our business; increased professional services of $0.1 million; and increased bad debt expense and other fees of $0.1 million, partially offset by lower non-employee stock-based compensation of $0.3 million relative to the same period a year ago.

Other Income (Expense), Net
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Other income (expense), net
$
(16
)
 
$
24

 
$
(40
)
 
NM
Percentage of revenues
0
 %
 
0
%
 
 
 
 

Other income (expense), net remained relatively constant during the three months ended September 30, 2014 compared to the three months ended September 30, 2013. Other income (expense) during the three months ended September 30, 2014 and 2013 consisted primarily of interest and investment income of $0.1 million, offset by foreign exchange losses of $0.1 million.
   
Provision for Income Taxes
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2014
 
2013
 
$
 
%
 
(in thousands, except percentages)
Provision for income taxes
$
283

 
$
210