QLYS-2015 Q1
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 March 31, 2015

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 April 30, 2015 was 33,955,829.


Table of Contents

Qualys, Inc.
TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
Item 1.
 
 
Condensed Consolidated Balance Sheets as of March 31, 2015 and December 31, 2014
 
 
 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014
 
 
 
 
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)
 
March 31, 2015
 
December 31, 2014
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
78,018

 
$
76,504

Short-term investments
64,932

 
50,714

Accounts receivable, net of allowance of $602 and $590 at March 31, 2015 and December 31, 2014, respectively
38,732

 
32,993

Deferred tax assets, current
6,862

 
8,520

Prepaid expenses and other current assets
7,305

 
6,528

Total current assets
195,849

 
175,259

Long-term investments
30,891

 
39,448

Property and equipment, net
28,279

 
26,618

Deferred tax assets, net
14,415

 
14,119

Intangible assets, net
1,903

 
2,001

Goodwill
317

 
317

Other noncurrent assets
2,254

 
2,262

Total assets
$
273,908

 
$
260,024

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,052

 
$
5,661

Accrued liabilities
10,547

 
10,353

Deferred revenues, current
87,929

 
81,147

Total current liabilities
100,528

 
97,161

Deferred revenues, noncurrent
10,064

 
10,064

Other noncurrent liabilities
1,042

 
972

Total liabilities
111,634

 
108,197

Commitments and contingencies (Note 5)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at March 31, 2015 and December 31, 2014

 

Common stock, $0.001 par value; 1,000,000,000 shares authorized, 33,934,868 and 33,594,285 shares issued and outstanding at March 31, 2015 and December 31, 2014, respectively
34

 
34

Additional paid-in capital
202,553

 
195,133

Accumulated other comprehensive income
35

 
10

Accumulated deficit
(40,348
)
 
(43,350
)
Total stockholders’ equity
162,274

 
151,827

Total liabilities and stockholders’ equity
$
273,908

 
$
260,024


See accompanying Notes to Condensed Consolidated Financial Statements


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Table of Contents

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

 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
Revenues
 
$
37,493

 
$
30,356

Cost of revenues
 
7,964

 
6,846

Gross profit
 
29,529

 
23,510

Operating expenses:
 
 
 
 
Research and development
 
7,150

 
6,404

Sales and marketing
 
11,443

 
12,492

General and administrative
 
6,016

 
4,875

Total operating expenses
 
24,609

 
23,771

Income (loss) from operations
 
4,920

 
(261
)
Other income (expense), net:
 
 
 
 
Interest expense
 

 
(4
)
Interest income
 
101

 
108

Other income (expense), net
 
(178
)
 
(92
)
Total other income (expense), net
 
(77
)
 
12

Income (loss) before income taxes
 
4,843

 
(249
)
Provision for income taxes
 
1,841

 
182

Net income (loss)
 
$
3,002

 
$
(431
)
Net income (loss) per share:
 
 
 
 
Basic
 
$
0.09

 
$
(0.01
)
Diluted
 
$
0.08

 
$
(0.01
)
Weighted average shares used in computing net income (loss) per share:
 
 
 
 
Basic
 
33,775

 
32,516

Diluted
 
38,235

 
32,516


See accompanying Notes to Condensed Consolidated Financial Statements


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Table of Contents

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

 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
Net income (loss)
 
$
3,002

 
$
(431
)
Available-for-sale investments:
 
 
 
 
Change in net unrealized gain (loss) on investments, net of zero tax
 
29

 
18

Less: reclassification adjustment for net realized gain included in net income
 
(4
)
 
(6
)
Net change, net of zero tax
 
25

 
12

Other comprehensive income, net
 
25

 
12

Comprehensive income (loss)
 
$
3,027

 
$
(419
)

See accompanying Notes to Condensed Consolidated Financial Statements




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Table of Contents

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


 
Three Months Ended March 31,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income (loss)
$
3,002

 
$
(431
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
3,182

 
2,805

Bad debt expense
175

 
14

Loss on disposal of property and equipment
4

 

Stock-based compensation
3,875

 
2,126

Amortization of premiums and accretion of discounts on investments
168

 
136

Excess tax benefits from stock-based compensation
(91
)
 
(17
)
Deferred income taxes
1,362

 
(8
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(5,914
)
 
6,680

Prepaid expenses and other assets
(670
)
 
270

Accounts payable
(3,609
)
 
88

Accrued liabilities
1,690

 
(547
)
Deferred revenues
6,782

 
3,924

Other noncurrent liabilities
70

 
66

Net cash provided by operating activities
10,026

 
15,106

Cash flows from investing activities:
 
 
 
Purchases of investments
(31,781
)
 
(47,451
)
Sales and maturities of investments
25,977

 
41,062

Purchases of property and equipment
(6,148
)
 
(3,802
)
Capitalized software development costs
(99
)
 

Net cash used in investing activities
(12,051
)
 
(10,191
)
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
3,448

 
1,256

Excess tax benefits from stock-based compensation
91

 
17

Principal payments under capital lease obligations

 
(267
)
Net cash provided by financing activities
3,539

 
1,006

Effect of exchange rate changes on cash and cash equivalents

 
6

Net increase in cash and cash equivalents
1,514

 
5,927

Cash and cash equivalents at beginning of period
76,504

 
42,369

Cash and cash equivalents at end of period
$
78,018

 
$
48,296

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Vesting of early exercised common stock options
$
6

 
$
29


See accompanying Notes to Condensed Consolidated Financial Statements



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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, 2014, included herein, was derived from the audited financial statements as of that date but does not include all disclosures, including notes required by U.S. GAAP. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the three month period ended March 31, 2015 is not necessarily indicative of the results of operations expected for the entire year ending December 31, 2015 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, 2014 filed with the SEC on March 6, 2015.

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

Correction of Immaterial Error
During the fourth quarter of 2014, the Company identified an immaterial error in the financial statements of its foreign subsidiaries reporting in the applicable local foreign currencies as their functional currencies, resulting in translation adjustments included as a component of accumulated other comprehensive income (loss) in stockholders' equity. It was determined that the functional currency for the Company's local subsidiaries should be the U.S. dollar. Accordingly, remeasurement gains and losses on monetary assets and liabilities denominated in foreign currencies should be recorded to foreign exchange gains and losses in other income (expense) in the condensed consolidated statements of operations in accordance with GAAP.


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

The Company reviewed the accounting error utilizing SEC Staff Accounting Bulletin No. 99, “Materiality” and SEC Staff Accounting Bulletin No. 108, “Effects of Prior Year Misstatements on Current Year Financial Statements.” Management evaluated the materiality of this error from a qualitative and quantitative perspective and determined the impact of the errors did not have a material impact on any individual prior period presentation or affect the trend of financial results. However, because the adjustment to correct the cumulative error on the consolidated balance sheets and statements of stockholders' equity would have had a material effect to the Company's consolidated statements of operations for the year ended December 31, 2014, the Company revised its previously reported financial statements for the 2012 and 2013 annual periods in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 filed with the SEC on March 6, 2015, to reflect the impact of the immaterial errors that had been corrected.
The following table summarizes the correction of previously reported amounts for the three month period ended March 31, 2014 presented in the accompanying condensed consolidated financial statements (in thousands, except per share data):
 
Three months ended
 
March 31, 2014
 
as reported
 
as adjusted
Condensed Consolidated Statements of Operations:
 
 
 
Other income (expense), net
$
(101
)
 
$
(92
)
Total other income (expense), net
3

 
12

Net loss
(440
)
 
(431
)
Net loss per share:
 
 
 
Basic
(0.01
)
 
(0.01
)
Diluted
(0.01
)
 
(0.01
)
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income:
 
 
 
Change in foreign currency translation gain, net of zero tax
9

 

Comprehensive loss
(419
)
 
(419
)
 
 
 
 
Condensed Consolidated Statements of Cash Flows:
 
 
 
Net cash provided by operating activities
15,075

 
15,106

Net cash used in investing activities
(10,167
)
 
(10,191
)
Effect of exchange rate changes on cash and cash equivalents
13

 
6

Net increase in cash and cash equivalents
5,927

 
5,927


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




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

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 once collection efforts are unsuccessful. As of March 31, 2015 and December 31, 2014, 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 fixed-income U.S. government agency securities, 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, 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 from contracts with customers. On April 1, 2015, the FASB tentatively decided to defer the effective date of ASU 2014-09. If the proposed changes are finalized, ASU 2014-09 will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, but entities will be permitted to early adopt the standard as of the original effective date. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with


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

the cumulative effect recognized on date of adoption. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements.

In January 2015, the FASB issued an ASU eliminating from U.S. GAAP the concept of extraordinary items, which required that an entity separately classify, present, and disclose extraordinary events and transactions. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of this ASU to be material to their consolidated financial statements.

In April 2015, the FASB issued an ASU amending existing guidance which clarifies that software licenses contained in a cloud computing arrangement should be capitalized if the customer has the right to take possession of the software and the ability to run the software outside of the cloud computing arrangement. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract under existing guidelines. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. Early adoption is permitted. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements.




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

NOTE 2.
Fair Value of Financial Instruments

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

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

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

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

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

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



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

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

 
 
March 31, 2015
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
33,097

 
$

 
$

 
$
33,097

Money market funds
 
41,722

 

 

 
41,722

Commercial paper
 
3,198

 
1

 

 
3,199

Total
 
78,017

 
1

 

 
78,018

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
8,929

 
7

 

 
8,936

Corporate bonds
 
11,206

 
4

 
(1
)
 
11,209

Asset-backed securities
 
225

 

 

 
225

U.S. government agencies
 
44,547

 
16

 
(1
)
 
44,562

Total
 
64,907

 
27

 
(2
)
 
64,932

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
13,874

 
4

 
(3
)
 
13,875

U.S. government agencies
 
13,907

 
9

 

 
13,916

Corporate bonds
 
3,101

 

 
(1
)
 
3,100

Total
 
30,882

 
13

 
(4
)
 
30,891

Total
 
$
173,806

 
$
41

 
$
(6
)
 
$
173,841


 
 
December 31, 2014
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
36,024

 
$

 
$

 
$
36,024

Money market funds
 
39,180

 

 

 
39,180

U.S. government agencies
 
300

 

 

 
300

Commercial paper
 
1,000

 

 

 
1,000

Total
 
76,504

 

 

 
76,504

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
4,998

 
1

 

 
4,999

Corporate bonds
 
12,438

 
6

 
(6
)
 
12,438

U.S. government agencies
 
33,280

 
3

 
(6
)
 
33,277

Total
 
50,716

 
10

 
(12
)
 
50,714

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
16,092

 
5

 
(3
)
 
16,094

U.S. government agencies
 
20,243

 
22

 
(10
)
 
20,255

Corporate bonds
 
3,101

 

 
(2
)
 
3,099

Total
 
39,436

 
27

 
(15
)
 
39,448

Total
 
$
166,656

 
$
37

 
$
(27
)
 
$
166,666




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


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

 
 
March 31, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$

 
$
12,135

 
$

 
$
12,135

U.S. government agencies
 

 
58,478

 

 
58,478

Corporate bonds
 

 
14,309

 

 
14,309

Asset-backed securities
 

 
14,100

 

 
14,100

Total
 
$

 
$
99,022

 
$

 
$
99,022


 
 
December 31, 2014
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$

 
$
5,999

 
$

 
$
5,999

U.S. government agencies
 

 
53,832

 

 
53,832

Corporate bonds
 

 
15,537

 

 
15,537

Asset-backed securities
 

 
16,094

 

 
16,094

Total
 
$

 
$
91,462

 
$

 
$
91,462




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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:

 
 
March 31, 2015
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
12,135

 
$

 
$

 
$
12,135

U.S. government agencies
 
44,562

 
13,916

 

 
58,478

Corporate bonds
 
11,209

 
3,100

 

 
14,309

Asset-backed securities
 
225

 
7,611

 
6,264

 
14,100

Total
 
$
68,131

 
$
24,627

 
$
6,264

 
$
99,022

 
 
December 31, 2014
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
5,999

 
$

 
$

 
$
5,999

U.S. government agencies
 
33,577

 
20,255

 

 
53,832

Corporate bonds
 
12,438

 
3,099

 

 
15,537

Asset-backed securities
 

 
7,327

 
8,767

 
16,094

Total
 
$
52,014

 
$
30,681

 
$
8,767

 
$
91,462

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

At March 31, 2015, the Company had two outstanding forward contracts with notional amounts of 5.1 million Euros and 2.1 million British Pounds, which expired on April 30, 2015. At December 31, 2014, the Company had two outstanding forward contracts with notional amounts of 6.0 million Euros and 2.1 million British Pounds, which expired on January 31, 2015. These forward contracts were entered into at the end of each month, and thus the fair value of these contracts was $0 at March 31, 2015 and December 31, 2014. The Company recorded a gain of $0.8 million from these forward contracts, which were more than offset by foreign currency transaction losses of $0.9 million for the three months ended March 31, 2015. The Company recorded losses of $0.2 million from these forward contracts, which were partially offset by foreign currency transaction gains of $0.1 million in the three months ended March 31, 2014. 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.



14

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


NOTE 3.
Property and Equipment, Net

Property and equipment consists of the following:
 
March 31,
 
December 31,
 
2015
 
2014
 
(in thousands)
Computer equipment
$
38,624

 
$
35,576

Computer software
11,523

 
10,899

Furniture, fixtures and equipment
2,825

 
2,931

Scanner appliances
20,783

 
19,861

Leasehold improvements
2,681

 
2,622

Total property and equipment
76,436

 
71,889

Less: accumulated depreciation and amortization
(48,157
)
 
(45,271
)
Property and equipment, net
$
28,279

 
$
26,618


Physical scanner appliances and other computer equipment that are or will be subject to subscriptions by customers have a net carrying value of $6.3 million and $6.0 million at March 31, 2015 and December 31, 2014, respectively, including assets that have not been placed in service of $1.3 million and $1.4 million, respectively. Other fixed assets not placed in service at March 31, 2015 and December 31, 2014, included in computer equipment and leasehold improvements, of approximately $4.8 million and $2.8 million, respectively. Depreciation and amortization expense relating to property and equipment was $3.1 million and $2.7 million for the three months ended March 31, 2015 and 2014, respectively.


15

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):
 
 
 
 
 
March 31, 2015
 
December 31, 2014
 
Estimated Lives
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Accumulated Amortization
 
Net Book Value
Existing technology
7 years
 
$
1,910

 
$
(1,251
)
 
$
659

 
$
(1,183
)
 
$
727

Patent license
14 years
 
1,388

 
(447
)
 
941

 
(422
)
 
966

Non-competition agreements and other
3 years
 
171

 
(163
)
 
8

 
(158
)
 
13

     Total intangibles subject to amortization
 
 
$
3,469

 
$
(1,861
)
 
1,608

 
$
(1,763
)
 
1,706

Intangible assets not subject to amortization
 
 
 
 
 
 
295

 
 
 
295

     Total intangible assets, net
 
 
 
 
 
 
$
1,903

 
 
 
$
2,001


Intangibles amortization expense was $0.1 million for the three months ended March 31, 2015 and 2014.

As of March 31, 2015, the Company expects amortization expense in future periods to be as follows (in thousands):
Remainder of 2015
$
288

2016
373

2017
282

2018
100

2019
100

2020 and thereafter
465

Total expected future amortization expense
$
1,608


Goodwill, which is not subject to amortization, totaled $0.3 million as of March 31, 2015 and December 31, 2014.
 


16

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 following are the minimum annual lease payments due under operating leases at March 31, 2015:
 
Operating Leases
 
(in thousands)
Remainder of 2015
$
3,172

2016
3,025

2017
1,817

2018
430

2019
217

Total minimum lease payments
$
8,661


Rent expense was $1.6 million and $1.5 million for the three months ended March 31, 2015 and 2014, 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 March 31, 2015 and December 31, 2014, the Company has accrued $0.5 million of deferred rent related to these agreements, which is reflected in accrued liabilities and other noncurrent liabilities in the accompanying condensed consolidated balance sheets.
   
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 March 31, 2015 and December 31, 2014, 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 March 31, 2015 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.



17

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

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 March 31, 2015, the Company has not recorded any material liabilities in accordance with accounting for contingencies.

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”), non-statutory stock options (“NSOs”), stock appreciation rights ("SARs"), restricted stock awards ("RSAs"), restricted stock units ("RSUs"), performance units and performance shares equivalent to up to 6,348,478 shares of common stock. Options may be granted with an exercise price that is at least equal to the fair market value of the Company's stock at the date of grant and are exercisable when vested. As of March 31, 2015, 2,358,920 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
 
 
March 31,
 
 
2015
 
2014
 
 
(in thousands)
Cost of revenues
 
$
328

 
$
149

Research and development
 
1,152

 
435

Sales and marketing
 
811

 
573

General and administrative
 
1,471

 
773

Total employee stock-based compensation
 
$
3,762

 
$
1,930


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 March 31, 2015, the Company had $25.6 million of total unrecognized employee compensation cost related to nonvested awards that it expects to recognize over a weighted-average period of 2.2 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:



18

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

 
 
Three months ended
 
 
March 31,
 
 
2015
 
2014
Expected term (in years)
 
4.9 to 5.9
 
5.3 to 5.9
Volatility
 
47% to 48%
 
51% to 52%
Risk-free interest rate
 
1.3%
 
1.5%
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.

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 $0.2 million for the three months ended March 31, 2015 and 2014, 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)
December 31, 2014
7,605,407

 
$
12.93

 
6.5
 
$
188,743

Granted
309,350

 
40.89

 
 
 
 
Exercised
(340,583
)
 
10.10

 
 
 
 
Canceled
(194,968
)
 
27.35

 
 
 
 
March 31, 2015
7,379,206

 
13.85

 
6.4
 
240,749

Vested and expected to vest - March 31, 2015
6,875,241

 
12.92

 
6.2
 
230,746

Exercisable - March 31, 2015
4,581,711

 
6.63

 
4.9
 
182,589


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.

The Company did not issue restricted stock during the three months ended March 31, 2015 or 2014.


19



NOTE 7.
Other Income (Expense), Net

Other income (expense), net consists of the following:
 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 
(in thousands)
Foreign exchange losses
 
$
(151
)
 
$
(67
)
Other income (expense)
 
(27
)
 
(25
)
Other income (expense), net
 
$
(178
)
 
$
(92
)



20

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

NOTE 8.
Income Taxes

The Company recorded a tax provision of $1.8 million and $0.2 million for the three months ended March 31, 2015 and 2014, respectively. The increase in the tax provision recorded for the three months ended March 31, 2015 is primarily due to the taxes on its U.S. federal income, as well as certain states and foreign jurisdictions, and changes to unrecognized tax benefits related to uncertain tax positions. Prior to the fourth quarter of 2014, the Company maintained a valuation allowance on its U.S. federal and state deferred tax assets, and its taxes were primarily related to taxes in its foreign jurisdictions and certain states in the U.S, as well as changes to unrecognized tax benefits related to uncertain tax positions. The Company's effective income tax rates was approximately 38% in the three months ended March 31, 2015.

As of both March 31, 2015 and December 31, 2014, the Company had unrecognized tax benefits of $3.3 million, of which $2.1 million, if recognized, 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
 
March 31,
 
2015
 
2014
 
(in thousands)
United States
$
26,341

 
$
21,327

Other
11,152

 
9,029

Total revenues
$
37,493

 
$
30,356



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

 
March 31,
 
December 31,
 
2015
 
2014
 
(in thousands)
United States
$
25,399

 
$
23,650

Other
2,880

 
2,968

Total property and equipment, net
$
28,279

 
$
26,618




21

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

NOTE 10.
Net Income (Loss) Per Share

The computations for basic and diluted net income (loss) per share are as follows:
 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 
(in thousands, except per share data)
Numerator:
 
 
 
 
Net income (loss)
 
$
3,002

 
$
(431
)
Denominator:
 
 
 
 
Weighted-average shares used in computing net income (loss) per share:
 
 
 
 
Basic
 
33,775

 
32,516

Effect of potentially dilutive securities:
 
 
 
 
Common stock options
 
4,460

 

Diluted
 
38,235

 
32,516

Net income (loss) per share:
 
 
 
 
Basic
 
$
0.09

 
$
(0.01
)
Diluted
 
$
0.08

 
$
(0.01
)

Potentially dilutive securities not included in the calculation of diluted net income (loss) per share because doing so would be antidilutive are as follows:
 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 
(in thousands)
Common stock options
 
535

 
6,272





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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, 2014, filed with the Securities and Exchange Commission, or SEC, on March 6, 2015.
In addition to historical information, this Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, it is possible to identify forward-looking statements because they contain words such as “anticipates,” “believes,” “contemplates,” “continue,” “could,” “estimates,” “expects,” “future,” “intends,” “likely,” “may,” “plans,” “potential,” “predicts,” “projects,” “seek,” “should,” “target,” or “will,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

our financial performance, including our revenues, costs, expenditures, growth rates, operating expenses and ability to generate positive cash flow to fund our operations and sustain profitability;
anticipated technology trends, such as the use of cloud solutions;
our ability to adapt to changing market conditions;
economic and financial conditions, including volatility in foreign exchange rates;
our ability to diversify our sources of revenues;
the effects of increased competition in our market;
our ability to innovate, enhance our cloud solutions and platform and introduce new solutions,;
our ability to effectively manage our growth;
our anticipated investments in sales and marketing, our infrastructure, new solutions, and research and development, and acquisitions;
maintaining and expanding our relationships with channel partners;
our ability to maintain, protect and enhance our brand and intellectual property;
costs associated with defending intellectual property infringement and other claims;
our ability to attract and retain qualified employees and key personnel;
our ability to successfully enter new markets and manage our international expansion;
our expectations, assumptions and conclusions related to our provision for income taxes and our deferred tax assets; 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


23

Table of Contents

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 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 (VM), in 2000. Our core VM solution has provided a substantial majority of our revenues to date, representing 79% and 83% of total revenues for the three months ended March 31, 2015 and 2014, 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 and 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 Continuous Monitoring 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 more 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 three month periods ended March 31, 2015 and 2014, 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.

Our revenues increased to $37.5 million in the three months ended March 31, 2015 from $30.4 million for the comparable period in 2014, representing an increase of $7.1 million or 24%. For the three months ended March 31, 2015 and 2014, we had net income of $3.0 million and a net loss $0.4 million, respectively.

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.

 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 
 (in thousands)
Adjusted EBITDA
 
$
11,977

 
$
4,670

Free cash flows
 
3,779

 
11,304




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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 (loss) 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 (loss) to Adjusted EBITDA for the three months ended March 31, 2015 and 2014:

 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 
 (in thousands, except percentages)
Net income (loss) (1)
 
$
3,002

 
$
(431
)
Other (income) expense, net (1)
 
77

 
(12
)
Provision for income taxes
 
1,841

 
182

Depreciation and amortization of property and equipment
 
3,084

 
2,707

Amortization of intangible assets
 
98

 
98

Stock-based compensation
 
3,875

 
2,126

Adjusted EBITDA
 
$
11,977

 
$
4,670

Percentage of revenues
 
32
%
 
15
%

(1) Other income (expense) and net loss for the three months ended March 31, 2014 have been adjusted for an immaterial error as further described in Note 1 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.


Free Cash Flow

We define free cash flow, a non-GAAP measure, as net cash provided by operating activities less purchases of property and equipment and capitalization of software development costs. We monitor free cash flow as a liquidity measure because we believe it provides useful information to management and investors about the amount of cash we generated, that, after the acquisition of property and equipment and capitalized software development costs, can be used for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening the balance sheet. We also believe free cash flow provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods.

A limitation of using free cash flow as a means for evaluating liquidity is that free cash flow does not represent the total increase or decrease in cash and cash equivalents for the period because it excludes cash provided by or used in other investing and financing activities. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to net cash


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provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:

 
 
Three Months Ended
 
 
March 31,
 
 
2015
 
2014
 
 (in thousands)
Net cash provided by operating activities
 
$
10,026

 
$
15,106

Less:
 
 
 
 
Purchases of property and equipment
 
(6,148
)
 
(3,802
)
Capitalized software development costs
 
(99
)
 

Free cash flow
 
$
3,779

 
$
11,304


Limitations of Adjusted EBITDA and Free Cash Flow

Adjusted EBITDA and free cash flow, 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:

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;
Free cash flow does not represent the total increase or decrease in the cash and cash equivalents for the period; and
Other companies, including companies in our industry, may calculate Adjusted EBITDA and free cash flow differently or not at all, which reduces their usefulness as a comparative measure.

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





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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 a substantial majority of our revenues through the sale of subscriptions to our QualysGuard Vulnerability Management solution, and we have a significant number of customers who have also 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. In some limited cases, we also provide certain computer equipment used to extend our QualysGuard Cloud Platform into our customers’ private cloud environment. Customers are required to return physical scanner appliances and computer equipment if they do not renew their subscriptions.

We typically invoice our customers for the entire subscription amount at the start of the subscription term. Invoiced amounts are reflected on our condensed consolidated balance sheets as accounts receivable or as cash when collected, and as deferred revenues until earned and recognized ratably over the subscription period. Accordingly, deferred revenues 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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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 with legal requirements.


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

Provision for Income Taxes
We are subject to federal, state and foreign income taxes for jurisdictions in which we operate, and we use estimates in determining our provision for these income taxes and deferred tax assets. Earnings from our non-U.S. activities are subject to income taxes in the local country which are generally lower than U.S. tax rates, and may be subject to U.S. income taxes. Our effective rates differ from the U.S. statutory rate primarily due to foreign income subject to different tax rates than the U.S., research and development tax credits, non-deductible stock-based compensation expense and other adjustments.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the tax impact of timing differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the statutory rate change is enacted into law.
We assess the likelihood that deferred tax assets will be realized, and we recognize a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be recognized. This assessment requires judgment as to the likelihood and amounts of future taxable income.
Our provision for income taxes in the first three months ended March 31, 2015 consists of income taxes for federal and certain states in the United States, as well as income taxes for profits generated in foreign jurisdictions by wholly owned subsidiaries. Our provision for income taxes in the first three months ended March 31, 2014 consists primarily of income taxes resulting from profits generated in foreign jurisdictions by wholly-owned subsidiaries, along with state income taxes payable in the United States, as we had maintained a valuation


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allowance on our U.S. federal and state net deferred tax assets in the first quarter of 2014. The provision for income taxes also includes changes to unrecognized tax benefits related to uncertain tax positions.

Results of Operations
The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented.
 
Three Months Ended
 
March 31,
 
2015
 
2014
 
(in thousands)
Condensed Consolidated Statements of Operations Data:
 
 
 
Revenues
$
37,493

 
$
30,356

Cost of revenues (1)
7,964

 
6,846

Gross profit
29,529

 
23,510

Operating expenses:
 
 
 
Research and development (1)
7,150

 
6,404

Sales and marketing (1)
11,443

 
12,492

General and administrative (1)
6,016

 
4,875

Total operating expenses
24,609

 
23,771

Income (loss) from operations
4,920


(261
)
Other income (expense), net (2)
(77
)
 
12

Income (loss) before income taxes (2)
4,843

 
(249
)
Provision for income taxes
1,841

 
182

Net income (loss) (2)
$
3,002

 
$
(431
)



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

 
Three Months Ended
 
March 31,
 
2015
 
2014
 
(in thousands)
Cost of revenues
$
328

 
$
149

Research and development
1,152

 
435

Sales and marketing
811

 
573

General and administrative
1,584

 
969

Total stock-based compensation
$
3,875

 
$
2,126



(2) Other income (expense), loss before income taxes, and net loss for the three months ended March 31, 2014 have been adjusted for an immaterial error as further described in Note 1 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.



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

 
Three Months Ended
 
March 31,
 
2015
 
2014
Revenues
100
 %
 
100
 %
Cost of revenues
21

 
23

Gross profit
79


77

Operating expenses:
 
 
 
Research and development
19

 
21

Sales and marketing
31

 
41

General and administrative
16

 
16

Total operating expenses
66


78

Income (loss) from operations
13


(1
)
Other income (expense), net
0

 
0

Income (loss) before income taxes
13


(1
)
Provision for income taxes
5

 
0

Net income (loss)
8
 %

(1
)%

Comparison of Three Months Ended March 31, 2015 and 2014
Revenues
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Revenues
$
37,493

 
$
30,356

 
$
7,137

 
24
%

Revenues increased $7.1 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to new customer subscriptions entered into after March 31, 2014 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $7.1 million, $5.0 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 the continued increased demand for our solutions.



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Cost of Revenues
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Cost of revenues
$
7,964

 
$
6,846

 
$
1,118

 
16
%
Percentage of revenues
21
%
 
23
%
 
 
 
 
Gross profit percentage
79
%
 
77
%
 
 
 
 
Cost of revenues increased $1.1 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to a $0.4 million increase in depreciation expenses related to additional computer hardware and software; increased third-party software license maintenance expense of $0.3 million; increased personnel expenses of $0.2 million, primarily due to increased stock based compensation; as well as increased data center costs of $0.1 million to support the continued growth of our business.

Research and Development Expenses
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Research and development
$
7,150

 
$
6,404

 
$
746

 
12
%
Percentage of revenues
19
%
 
21
%
 
 
 
 

Research and development expenses increased $0.7 million in the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to an increase in personnel expenses of $0.8 million, principally due to higher stock-based compensation. We continue to significantly invest in and expand our research and development team in India to continue enhancing our platform and develop new solutions and capabilities.


Sales and Marketing Expenses
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Sales and marketing
$
11,443

 
$
12,492

 
$
(1,049
)
 
(8
)%
Percentage of revenues
31
%
 
41
%
 
 
 
 

Sales and marketing expenses decreased $1.0 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to a decrease in marketing expenses of $0.9 million, due to decreased trade shows, program activities and decreased travel related costs of $0.2 million, primarily as a result of the timing difference of a major security trade show in the first quarter of 2014, which will occur in the second quarter of this fiscal year.



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General and Administrative Expenses
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
General and administrative
$
6,016

 
$
4,875

 
$
1,141

 
23
%
Percentage of revenues
16
%
 
16
%
 
 
 
 

General and administrative expenses increased $1.1 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily driven by increased personnel expenses of $0.7 million, principally due to higher employee stock-based compensation; increased professional services of $0.2 million; and increased bad debt expense and other fees of $0.2 million.

Other Income (Expense), Net
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Other income (expense), net
$
(77
)
 
$
12

 
$
(89
)
 
NM
Percentage of revenues
0
 %
 
0
%
 
 
 
 

Other income (expense), net decreased by $0.1 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily driven by an increase in foreign exchange losses of $0.1 million.
   
Provision for Income Taxes
 
Three Months Ended
 
 
 
 
 
March 31,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Provision for income taxes
$
1,841

 
$
182

 
$
1,659

 
NM
Percentage of revenues
5
%
 
0
%
 
 
 
 

Provision for income taxes increased $1.7 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to the provision for U.S. federal taxes in the first quarter of 2015. As we had maintained a valuation allowance against our U.S. federal and state deferred tax assets prior to the fourth quarter of 2014, our income tax provision for the three months ended March 31, 2014 was primarily made up of taxes on income in foreign jurisdictions and certain states in the United States.



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Liquidity and Capital Resources

At March 31, 2015, our principal source of liquidity was cash, cash equivalents, and short-term and long-term investments of $173.8 million, including $2.9 million held outside of the United States by our foreign subsidiaries. We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. However, if we repatriate these funds, we could be subject to U.S. income taxes on such amounts, less previously paid foreign income taxes.

We have experienced positive cash flows from operations during the three months ended March 31, 2015 and 2014. We believe our existing cash, cash equivalents, short-term and long-term investments, and cash from operations will be sufficient to fund our operations for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our spending on research and development efforts, international expansion and investment in data centers. We may also seek to invest in or acquire complementary businesses or technologies.

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

 
Three Months Ended
 
March 31,
 
2015
 
2014
 
(in thousands)
Cash provided by operating activities
$
10,026

 
$
15,106

Cash used in investing activities
(12,051
)
 
(10,191
)
Cash provided by financing activities
3,539

 
1,006

Effect of exchange rate changes on cash and cash equivalents

 
6

Net increase in cash and cash equivalents
$
1,514

 
$
5,927


Cash Flows from Operating Activities

In the three months ended March 31, 2015, cash flows from operating activities of $10.0 million resulted from our net income of approximately $3.0 million, as adjusted by an increase in deferred revenues of $6.8 million, attributable to our continued growth, and by non-cash items including depreciation and amortization expense of $3.2 million and stock-based compensation of $3.9 million. These increases are partially offset by an increase in accounts receivable of $5.9 million, due to timing of orders received relatively later in the quarter, and by an increase in accounts payable of $3.6 million due to timing of payments.

In the three months ended March 31, 2014, cash flows from operating activities of $15.1 million resulted from a decrease in accounts receivable of $6.7 million due to lower bookings in the first quarter compared to the fourth quarter of the prior year and also due to collection of early first quarter bookings; an increase of $3.9 million in deferred revenues attributable to our continued growth. These working capital increases are partially offset by a net loss of $0.4 million, adjusted by non-cash items including depreciation and amortization of $2.8 million and stock-based compensation of $2.1 million.
Cash Flows from Investing Activities
In the three months ended March 31, 2015, cash used in investing activities of $12.1 million was primarily attributable to $6.1 million of cash for capital expenditures, including computer hardware and software for our data centers to support our growth and development and physical scanner appliances and computer hardware provided


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to certain customers as part of their subscriptions; and purchases of investments of $31.8 million, partially offset by sales and maturities of investments of $26.0 million.

In the three months ended March 31, 2014, cash used in investing activities of $10.2 million was primarily attributable to $3.8 million of cash for capital expenditures, including computer hardware and software for our data centers to support our growth and development and physical scanner appliances provided to certain customers as part of their subscriptions. There were also purchases of investments of $47.5 million, partially offset by sales and maturities of investments of $41.1 million.

Cash Flows from Financing Activities

In the three months ended March 31, 2015, cash provided by financing activities of $3.5 million was primarily attributable to $3.4 million of proceeds from the exercise of stock options.

In the three months ended March 31, 2014, cash provided by financing activities of $1.0 million was primarily attributable to $1.3 million of proceeds from the exercise of stock options, partially offset by repayments on our capital lease obligations of $0.3 million.

Contractual Obligations
Our principal commitments consist of obligations under our outstanding leases for office space, third-party data centers and certain office equipment. The following table summarizes our contractual cash obligations at March 31, 2015 and the effect such obligations are expected to have on our liquidity and cash flows in future periods:
 
Payment Due by Period
Contractual Obligations
Total
 
Remainder of 2015
 
2016-2017
 
2018-2019
 
(in thousands)
Operating lease obligations (1)
$
8,661

 
$
3,172

 
$
4,842

 
$
647

Total
$
8,661

 
$
3,172

 
$
4,842

 
$
647


(1) Operating lease obligations represent our obligations to make payments under the lease agreements for our facilities, data centers, and office equipment leases. During the three months ended March 31, 2015, we made regular payments on our operating lease obligations of $1.4 million.



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

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


Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, we evaluate our


34


estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in the notes to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, filed with the SEC on March 6, 2015, the accounting policies related to revenue recognition, income taxes and stock-based compensation involve the greatest degree of judgment and complexity and have the greatest potential impact on our consolidated financial statements. A critical accounting policy is one that is material to the presentation of our consolidated financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.




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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Foreign Currency Risk

Our results of operations and cash flows have been and will continue to be subject to fluctuations because of changes in foreign currency exchange rates, particularly changes in exchange rates between the U.S. dollar and the Euro and British pound, the currencies of countries where we currently have our most significant international operations. A portion of our invoicing is denominated in the Euro, British Pound and Japanese Yen. Our expenses in international locations are generally denominated in the currencies of the countries in which our operations are located.

Derivative financial instruments are utilized by the Company to reduce foreign currency exchange risks. We use foreign currency forward contracts to partially mitigate the impact of fluctuations in cash and accounts receivable balances denominated in Euros and British Pound. We do not use these contracts for speculative or trading purposes, nor are they designated as hedges. These contracts typically have a maturity of one month, and we record gains and losses from these instruments in other income (expense), net. The effect of an immediate 10% adverse change in foreign exchange rates would not be material to our financial condition, operating results or cash flows.
Interest Rate Sensitivity
We have $173.8 million in cash, cash equivalents and short-term and long-term investments at March 31, 2015. Cash and cash equivalents include cash held in banks and highly liquid money market funds, U.S. government agency securities, and commercial paper. Investments consist of fixed-income U.S. government agency securities, corporate bonds, asset-backed securities, and commercial paper. All of these investments, excluding long-term investments, have maturities of less than one year from date of purchase. Long-term investments have maturities that extend more than one year from date of purchase.
The primary objectives of our investment activities are the preservation of principal and support of our liquidity requirements. We do not enter into investments for trading or speculative purposes. Our investments are subject to market risk due to changes in interest rates, which may affect the interest income we earn and the fair market value. Due to the nature of these investments held as available-for-sale securities, we do not believe that a 10% increase or decrease in interest rates would have a material impact on our operating results or cash flows.


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Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2015. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2015, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

Item 1A.
Risk Factors

An investment in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, and all other information contained in this Quarterly Report on Form 10-Q, including our condensed consolidated financial statements and the related notes, before making a decision to invest in our common stock. Our business, operating results, financial condition, or prospects could be materially and adversely affected by any of these risks and uncertainties. In that case, the trading price of our common stock could decline, and you might lose all or part or all of your investment. In addition, the risks and uncertainties discussed below are not the only ones we face. Our business, operating results, financial performance or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material.

If the market for cloud solutions for IT security and compliance does not evolve as we anticipate, our revenues may not grow and our operating results would be harmed.

Our success depends to a significant extent on the willingness of organizations to increase their use of cloud solutions for their IT security and compliance. However, the market for cloud solutions for IT security and compliance is at an early stage relative to on-premise solutions, and as such, it is difficult to predict important market trends, including the potential growth, if any, of the market for cloud security and compliance solutions. To date, some organizations have been reluctant to use cloud solutions because they have concerns regarding the risks associated with the reliability or security of the technology delivery model associated with these solutions. If other cloud service providers experience security incidents, loss of customer data, disruptions in service delivery or other problems, the market for cloud solutions as a whole, including our solutions, may be negatively impacted. Moreover, many organizations have invested substantial personnel and financial resources to integrate on-premise software into their businesses, and as a result may be reluctant or unwilling to migrate to a cloud solution. Organizations that use on-premise security products, such as network firewalls, security information and event management products or data loss prevention solutions, may also believe that these products sufficiently protect their IT infrastructure and deliver adequate security. Therefore, they may continue spending their IT security budgets on these products and may not adopt our security and compliance solutions in addition to or as a replacement for such products.

If the market for cloud solutions for IT security and compliance does not evolve in the way we anticipate or if customers do not recognize the benefits of our cloud solutions over traditional on-premise enterprise software products, and as a result we are unable to increase sales of subscriptions to our solutions, then our revenues may not grow or may decline, and our operating results would be harmed.

Our quarterly operating results may vary from period to period, which could result in our failure to meet expectations with respect to operating results and cause the trading price of our stock to decline.

Our operating results have historically varied from period to period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control, including:
the level of demand for our solutions;
publicity regarding security breaches generally and the level of perceived threats to IT security;
sales and marketing expenses associated with our existing and new products and services;
changes in customer renewals of our solutions;
the extent to which customers subscribe for additional solutions;


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seasonal buying patterns of our customers;
the level of perceived threats to IT security;
security breaches, technical difficulties or interruptions with our service;
changes in the growth rate of the IT security and compliance market;
the timing and success of new product or service introductions by us or our competitors or any other changes in the competitive landscape of our industry, including consolidation among our competitors;
the introduction or adoption of new technologies that compete with our solutions;
decisions by potential customers to purchase IT security and compliance products or services from other vendors;
the amount and timing of operating costs and capital expenditures related to the operations and expansion of our business;
the timing of sales commissions relative to the recognition of revenues;
the announcement or adoption of new regulations and policy mandates or changes to existing regulations and policy mandates;
failure of our products and services to operate as designed;
price competition;
the length of our sales cycle for our products and services;
insolvency or credit difficulties confronting our customers, affecting their ability to purchase or pay for our solutions;
changes in foreign currency exchange rates;
general economic conditions, both domestically and in the foreign markets in which we sell our solutions;
future accounting pronouncements or changes in our accounting policies;
our ability to integrate any products or services that we may acquire in the future into our product suite or migrate existing customers of any companies that we may acquire in the future to our products and services;
the timing of expenses related to the development or acquisition of technologies, services or businesses; and
potential goodwill and intangible asset impairment charges associated with acquired businesses.

Each factor above or discussed elsewhere in this Quarterly Report on Form 10-Q or the cumulative effect of some of these factors may result in fluctuations in our operating results. This variability and unpredictability could result in our failure to meet expectations with respect to operating results, or those of securities analysts or investors, for a particular period. In addition, a significant percentage of our operating expenses are fixed in nature and based on forecasted trends in revenues. Accordingly, in the event of shortfalls in revenues, we are generally unable to mitigate the negative impact on margins in the short term by reducing our operating expenses. If we fail to meet or exceed expectations for our operating results for these or any other reasons, the trading price of our common stock could fall and we could face costly lawsuits, including securities class action suits.

If we do not successfully anticipate market needs and opportunities or are unable to enhance our solutions and develop new solutions that meet those needs and opportunities on a timely or cost-effective basis, we may not be able to compete effectively and our business and financial condition may be harmed.

The IT security and compliance market is characterized by rapid technological advances, changes in customer requirements, frequent new product introductions and enhancements and evolving industry standards and regulatory mandates. We must also continually change and improve our solutions in response to changes in operating systems, application software, computer and communications hardware, networking software, data center architectures, programming tools and computer language technology.


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We may not be able to anticipate future market needs and opportunities or develop enhancements or new solutions to meet such needs or opportunities in a timely manner or at all. The market for cloud solutions for IT security and compliance is relatively new, and it is uncertain whether our new solutions will gain market acceptance.

Our solution enhancements or new solutions could fail to attain sufficient market acceptance for many reasons, including:
failure to timely meet market demand for product functionality;
inability to identify and provide intelligence regarding the attacks or techniques used by cyber attackers;
inability to interoperate effectively with the database technologies, file systems or web applications of our prospective customers;
defects, errors or failures;
delays in releasing our enhancements or new solutions;
negative publicity about their performance or effectiveness;
introduction or anticipated introduction of products by our competitors;
poor business conditions, causing customers to delay IT security and compliance purchases;
easing or changing of external regulations related to IT security and compliance; and
reluctance of customers to purchase cloud solutions for IT security and compliance.

Furthermore, diversifying our solutions and expanding into new IT security and compliance markets will require significant investment and planning, require that our research and development and sales and marketing organizations develop expertise in these new markets, bring us more directly into competition with security and compliance providers that may be better established or have greater resources than we do, require additional investment of time and resources in the development and training of our channel partners and entail significant risk of failure.

If we fail to anticipate market requirements or fail to develop and introduce solution enhancements or new solutions to satisfy those requirements in a timely manner, such failure could substantially decrease or delay market acceptance and sales of our present and future solutions and cause us to lose existing customers or fail to gain new customers, which would significantly harm our business, financial condition and results of operations.

If we fail to continue to effectively scale and adapt our platform to meet the performance and other requirements of our customers, our operating results and our business would be harmed.

Our future growth is dependent upon our ability to continue to meet the expanding needs of our customers as their use of our cloud platform grows. As these customers gain more experience with our solutions, the number of users and the number of locations where our solutions are being accessed may expand rapidly in the future. In order to ensure that we meet the performance and other requirements of our customers, we intend to continue to
make significant investments to develop and implement new proprietary and third-party technologies at all levels of our cloud platform. These technologies, which include databases, applications and server optimizations, and network and hosting strategies, are often complex, new and unproven. We may not be successful in developing or implementing these technologies. To the extent that we do not effectively scale our platform to maintain performance as our customers expand their use of our platform, our operating results and our business may be harmed.

Our platform, website and internal systems may be subject to intentional disruption or other security incidents that could result in liability and adversely impact our reputation and future sales.

We and our service providers could be a target of cyber attacks or other malfeasance designed to impede the performance of our solutions, penetrate our network security or the security of our cloud platform or our internal systems, misappropriate proprietary information and/or cause interruptions to our services. Our solutions, platforms, and system may also suffer security incidents as a result of non-technical issues, including intentional or


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inadvertent breaches by our employees or service providers. Because our operations involve providing IT security solutions to our customers, we may be targeted for cyber attacks and other security incidents. If an actual or perceived breach of our security measures or those of our service providers occurs, it could adversely affect the market perception of our solutions, negatively affecting our reputation, and may expose us to the loss of information, litigation, regulatory actions and possible liability. Any such actual or perceived security breach could also divert the efforts of our technical and management personnel. In addition, any such actual or perceived security breach could impair our ability to operate our business and provide solutions to our customers. If this happens, our reputation could be harmed, our revenues could decline and our business could suffer.

We have a limited history of profitability and may not achieve or maintain profitability in the future.

While we have experienced significant revenue growth in recent years and although we have had net income for each of the three years ended December 31, 2014, 2013, and 2012, we have not been consistently profitable. We have had net losses in at least one quarter in each of the last several years, including a net loss of $0.4 million for the three months ended March 31, 2014. We may not be able to sustain or increase our growth or maintain profitability in the future. We plan to continue to invest in our infrastructure, new solutions, research and development and sales and marketing, and as a result, we cannot assure you that we will maintain profitability. In addition, we will continue to incur increased personnel and professional services expenses in connection with compliance with Section 404 of the Sarbanes-Oxley Act. As a result of these increased expenditures, we will have to generate and sustain increased revenues to achieve future profitability. We may incur losses in the future for a number of reasons, including without limitation, the other risks and uncertainties described in this Quarterly Report on Form 10-Q. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unknown factors that may result in losses in future periods. If our revenue growth does not meet our expectations in future periods, our financial performance may be harmed and we may not again achieve or maintain profitability in the future.

Adverse economic conditions or reduced IT spending may adversely impact our business.

Our business depends on the overall demand for IT and on the economic health of our current and prospective customers. In general, worldwide economic conditions remain unstable, and these conditions make it difficult for our customers, prospective customers and us to forecast and plan future business activities accurately, and they could cause our customers or prospective customers to reevaluate their decision to purchase our solutions. Weak global economic conditions, or a reduction in IT spending even if economic conditions improve, could adversely impact our business, financial condition and results of operations in a number of ways, including longer sales cycles, lower prices for our solutions, reduced bookings and lower or no growth.

Our business depends substantially on retaining our current customers, and any reduction in our customer renewals or revenues from such customers could harm our future operating results.

We offer our QualysGuard Cloud Platform and integrated suite of solutions pursuant to a software-as-a-service model, and our customers purchase subscriptions from us that are generally one year in length. Our customers have no obligation to renew their subscriptions after their subscription period expires, and they may not renew their subscriptions at the same or higher levels or at all. As a result, our ability to grow depends in part on customers renewing their existing subscriptions and purchasing additional subscriptions and solutions. Our customers may choose not to renew their subscriptions to our solutions or purchase additional solutions due to a number of factors, including their satisfaction or dissatisfaction with our solutions, the prices of our solutions, the prices of products or services offered by our competitors, reductions in our customers’ spending levels due to the macroeconomic environment or other factors. If our customers do not renew their subscriptions to our solutions, renew on less favorable terms, or do not purchase additional solutions or subscriptions, our revenues may grow more slowly than expected or decline and our results of operations may be harmed.

If we are unable to continue to attract new customers and grow our customer base, our growth could be slower than we expect and our business may be harmed.

We believe that our future growth depends in part upon increasing our customer base. Our ability to achieve significant growth in revenues in the future will depend, in large part, upon continually attracting new customers and


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obtaining subscription renewals to our solutions from those customers. If we fail to attract new customers our revenues may grow more slowly than expected and our business may be harmed.

Subscriptions to our QualysGuard Vulnerability Management solution generate most of our revenues, and if we are unable to continue to renew and grow subscriptions for this solution, our operating results would suffer.

We derived 79% and 83% of our revenues from subscriptions to our core QualysGuard Vulnerability Management solution for the three months ended March 31, 2015 and 2014, respectively, and we expect to continue to derive a significant majority of our revenues from sales of subscriptions to this solution for the foreseeable future. As a result, the market demand for our QualysGuard Vulnerability Management solution is critical to our continued success. Demand for this solution is affected by a number of factors beyond our control, including continued market acceptance of our solution for existing and new use cases, the timing of development and release of new products or services by our competitors, technological change, and growth or contraction in our market. Our inability to renew or increase subscriptions for this solution or a decline in price of this solution would harm our business and operating results more seriously than if we derived significant revenues from a variety of solutions.

If we are unable to sell subscriptions to additional solutions, our future revenue growth may be harmed and our business may suffer.

We will need to increase the revenues that we derive from our current and future solutions other than QualysGuard Vulnerability Management for our business and revenues to grow as we expect. Revenues from our other solutions, including our Web Application Scanning, Policy Compliance, PCI Compliance, Malware Detection Service, and Qualys SECURE Seal, have been relatively modest compared to revenues from our QualysGuard Vulnerability Management solution. Our future success depends in part on our ability to sell subscriptions to these additional solutions to existing and new customers. This may require more costly sales and marketing efforts and may not result in additional sales. If our efforts to sell subscriptions to additional solutions to existing and new customers are not successful, our business may suffer.

Our security and compliance solutions are primarily delivered from four data centers, and any disruption of service at these facilities would interrupt or delay our ability to deliver our solutions to our customers which could reduce our revenues and harm our operating results.

We currently host substantially all of our solutions from four third-party data centers, located in the United States and Switzerland. These facilities are vulnerable to damage or interruption from earthquakes, hurricanes, floods, fires, cybersecurity attacks, terrorist attacks, employee negligence, power losses, telecommunications failures and similar events. The facilities also could be subject to break-ins, sabotage, intentional acts of vandalism and other misconduct. The occurrence of a natural disaster, an act of terrorism or misconduct, a decision to close the facilities without adequate notice or other unanticipated problems could result in interruptions in our services.

Our data centers are not currently redundant and we cannot rapidly move customers from one data center to another, which may increase delays in the restoration of our service for our customers if an adverse event occurs. We have added data center facilities to provide additional capacity for our cloud platform and to enable disaster recovery. We continue to build out these facilities and expect to add additional data centers throughout 2015. However, these additional facilities may not be operational in the anticipated time-frame and we may incur unplanned expenses.

Additionally, our existing data center facilities providers have no obligations to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew our agreements with the facilities providers on commercially reasonable terms or if in the future we add additional data center facility providers, we may experience costs or downtime in connection with the loss of an existing facility or the transfer to, or addition of, new data center facilities.

Any disruptions or other performance problems with our solutions could harm our reputation and business and may damage our customers’ businesses. Interruptions in our service delivery might reduce our revenues, cause us


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to issue credits to customers, subject us to potential liability and cause customers to terminate their subscriptions or not renew their subscriptions.

If we are unable to increase market awareness of our company and our new solutions, our revenues may not continue to grow, or may decline.

We have a limited operating history, particularly in certain markets and solution offerings, and we believe that we need to continue to develop market awareness in the IT security and compliance market. Market awareness of our capabilities and solutions is essential to our continued growth and success in all of our markets, particularly for the large enterprise, service provider and government markets. If our marketing programs are not successful in creating market awareness of our company and our full suite of solutions, our business, financial condition and results of operations may be adversely affected, and we may not be able to achieve our expected growth.

If our solutions fail to help our customers achieve and maintain compliance with regulations and industry standards, our revenues and operating results could be harmed.

We generate a portion of our revenues from solutions that help organizations achieve and maintain compliance with regulations and industry standards. For example, many of our customers subscribe to our security and compliance solutions to help them comply with the security standards developed and maintained by the Payment Card Industry Security Standards Council, or the PCI Council, which apply to companies that store cardholder data. Industry organizations like the PCI Council may significantly change their security standards with little or no notice, including changes that could make their standards more or less onerous for businesses. Governments may also adopt new laws or regulations, or make changes to existing laws or regulations, that could impact the demand for or value of our solutions.

If we are unable to adapt our solutions to changing regulatory standards in a timely manner, or if our solutions fail to assist with or expedite our customers’ compliance initiatives, our customers may lose confidence in our solutions and could switch to products offered by our competitors. In addition, if regulations and standards related to data security, vulnerability management and other IT security and compliance requirements are relaxed or the penalties for non-compliance are changed in a manner that makes them less onerous, our customers may view government and industry regulatory compliance as less critical to their businesses, and our customers may be less willing to purchase our solutions. In any of these cases, our revenues and operating results could be harmed.

If our solutions fail to detect vulnerabilities or incorrectly detect vulnerabilities, our brand and reputation could be harmed, which could have an adverse effect on our business and results of operations.

If our solutions fail to detect vulnerabilities in our customers’ IT infrastructures, or if our solutions fail to identify and respond to new and increasingly complex methods of attacks, our business and reputation may suffer. There is no guarantee that our solutions will detect all vulnerabilities. Additionally, our security and compliance solutions may falsely detect vulnerabilities or threats that do not actually exist. For example, some of our solutions rely on information on attack sources aggregated from third-party data providers who monitor global malicious activity originating from a variety of sources, including anonymous proxies, specific IP addresses, botnets and phishing sites. If the information from these data providers is inaccurate, the potential for false indications of security vulnerabilities increases. These false positives, while typical in the industry, may impair the perceived reliability or usability of our solutions and may therefore adversely impact market acceptance of our solutions and could result in negative publicity, loss of customers and sales, increased costs to remedy any incorrect information or problem, or claims by aggrieved parties. Similar issues may be generated by the misuse of our tools to identify and exploit vulnerabilities.

In addition, our solutions do not currently extend to cover mobile devices or personal devices that employees may bring into an organization. As such, our solutions would not identify or address vulnerabilities in mobile devices, such as mobile phones or tablets, or personal devices, and our customers’ IT infrastructures may be compromised by attacks that infiltrate their networks through such devices.

An actual or perceived security breach or theft of the sensitive data of one of our customers, regardless of whether the breach is attributable to the failure of our solutions, could adversely affect the market’s perception of our security solutions.


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Incorrect or improper implementation or use of our solutions could result in customer dissatisfaction and harm our business and reputation.

Our solutions are deployed in a wide variety of IT environments, including large-scale, complex infrastructures. If our customers are unable to implement our solutions successfully, customer perceptions of our platform may be impaired or our reputation and brand may suffer. Our customers have in the past inadvertently misused our solutions, which triggered downtime in their internal infrastructure until the problem was resolved. Any misuse of our solutions could result in customer dissatisfaction, impact the perceived reliability of our solutions, result in negative press coverage, negatively affect our reputation and harm our financial results.

Undetected software errors or flaws in our cloud platform could harm our reputation or decrease market acceptance of our solutions, which would harm our operating results.

Our solutions may contain undetected errors or defects when first introduced or as new versions are released. We have experienced these errors or defects in the past in connection with new solutions and solution upgrades and we expect that these errors or defects will be found from time to time in the future in new or enhanced solutions after commercial release of these solutions. Since our customers use our solutions for security and compliance reasons, any errors, defects, disruptions in service or other performance problems with our solutions may damage our customers’ business and could hurt our reputation. If that occurs, we may incur significant costs, the attention of our key personnel could be diverted, our customers may delay or withhold payment to us or elect not to renew, or other significant customer relations problems may arise. We may also be subject to liability claims for damages related to errors or defects in our solutions. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our solutions may harm our business and operating results.

Our solutions could be used to collect and store personal information of our customers’ employees or customers, and therefore privacy and other data handling concerns could result in additional cost and liability to us or inhibit sales of our solutions.

We collect the names and email addresses of our customers in connection with subscriptions to our solutions. Additionally, the data that our solutions collect to help secure and protect the IT infrastructure of our customers may include additional personal or confidential information of our customers’ employees and their customers. Personal privacy has become a significant issue in the United States and in many other countries where we offer our solutions. The regulatory framework for privacy issues worldwide is currently evolving and is likely to remain uncertain for the foreseeable future. Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws and regulations regarding the collection, use, disclosure and retention of personal information. In the United States, these include, for example, rules and regulations promulgated under the authority of the Federal Trade Commission, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, the Gramm-Leach-Bliley Act, or GLB, and state breach notification laws. Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal framework with which we or our customers must comply, including the Data Protection Directive established in the European Union and the Federal Data Protection Act passed in Germany.

In addition to laws and regulations, privacy advocacy and industry groups or other private parties may propose new and different privacy standards that either legally or contractually apply to us. Because the interpretation and application of privacy and data protection laws, regulations, standards and contractual obligations are uncertain, it is possible that they may be interpreted and applied in a manner that is, or perceived to be, inconsistent with our data management practices or the features of our solutions. If so, in addition to the possibility of regulatory investigations and enforcement actions, fines, lawsuits and other claims, other forms of injunctive or operations-limiting relief, and damage to our reputations and loss of goodwill, we could be required to fundamentally change our business activities and practices or modify our solutions and may face limitations in our ability to develop new solutions and features, any of which could have an adverse effect on our business. Any inability to adequately address privacy concerns, even if unfounded, or any actual or perceived inability to comply with applicable privacy or data protection laws, regulations and privacy standards, could result in cost and liability to us, damage our reputation, inhibit sales of subscriptions and harm our business.



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Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and privacy standards that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our solutions. Privacy concerns, whether valid or not valid, may inhibit market adoption of our solutions particularly in certain industries and foreign countries.

A significant portion of our customers, channel partners and employees are located outside of the United States, which subjects us to a number of risks associated with conducting international operations and if we are unable to successfully manage these risks, our business and operating results could be harmed.

We market and sell subscriptions to our solutions throughout the world and have personnel in many parts of the world. In addition, we have sales offices and research and development facilities outside the United States and we conduct, and expect to continue to conduct, a significant amount of our business with organizations that are located outside the United States, particularly in Europe and Asia. Therefore, we are subject to risks associated with having international sales and worldwide operations, including:
foreign currency exchange fluctuations;
trade and foreign exchange restrictions;
economic or political instability in foreign markets;
greater difficulty in enforcing contracts, accounts receivable collection and longer collection periods;
changes in regulatory requirements;
difficulties and costs of staffing and managing foreign operations;
the uncertainty and limitation of protection for intellectual property rights in some countries;
costs of compliance with foreign laws and regulations and the risks and costs of non-compliance with such laws and regulations;
costs of complying with U.S. laws and regulations for foreign operations, including the Foreign Corrupt Practices Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory or contractual limitations on our ability to sell our solutions in certain foreign markets, and the risks and costs of non-compliance;
heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, and irregularities in, financial statements;