10-Q
Table of Contents

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

For the Quarterly Period Ended September 30, 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 October 30, 2015 was 34,194,842.


Table of Contents

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



2

Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
Qualys, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share and per share data)
 
September 30, 2015
 
December 31, 2014
 
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
94,763

 
$
76,504

Short-term investments
79,382

 
50,714

Accounts receivable, net of allowance of $622 and $590 as of September 30, 2015 and December 31, 2014, respectively
37,876

 
32,993

Deferred tax assets, current
4,353

 
8,520

Prepaid expenses and other current assets
8,947

 
6,528

Total current assets
225,321

 
175,259

Long-term investments
25,732

 
39,448

Property and equipment, net
29,965

 
26,618

Deferred tax assets, net
13,180

 
14,119

Intangible assets, net
1,708

 
2,001

Goodwill
317

 
317

Other noncurrent assets
2,065

 
2,262

Total assets
$
298,288

 
$
260,024

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,055

 
$
5,661

Accrued liabilities
11,358

 
10,353

Deferred revenues, current
91,939

 
81,147

Total current liabilities
105,352

 
97,161

Deferred revenues, noncurrent
9,884

 
10,064

Other noncurrent liabilities
1,154

 
972

Total liabilities
116,390

 
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 September 30, 2015 and December 31, 2014

 

Common stock, $0.001 par value; 1,000,000,000 shares authorized; 34,166,512 and 33,594,285 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively
34

 
34

Additional paid-in capital
214,736

 
195,133

Accumulated other comprehensive income
37

 
10

Accumulated deficit
(32,909
)
 
(43,350
)
Total stockholders’ equity
181,898

 
151,827

Total liabilities and stockholders’ equity
$
298,288

 
$
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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenues
$
42,469

 
$
34,348

 
$
119,839

 
$
97,006

Cost of revenues
8,762

 
7,421

 
24,883

 
21,442

Gross profit
33,707

 
26,927

 
94,956

 
75,564

Operating expenses:
 
 
 
 
 
 
 
Research and development
7,564

 
6,490

 
21,919

 
19,305

Sales and marketing
12,282

 
11,774

 
36,501

 
36,111

General and administrative
6,983

 
5,156

 
19,426

 
15,112

Total operating expenses
26,829

 
23,420

 
77,846

 
70,528

Income from operations
6,878

 
3,507

 
17,110

 
5,036

Other income (expense), net:
 
 
 
 
 
 
 
Interest expense

 
(2
)
 
(4
)
 
(9
)
Interest income
153

 
127

 
386

 
365

Other income (expense), net
(307
)
 
(244
)
 
(485
)
 
(422
)
Total other income (expense), net
(154
)
 
(119
)
 
(103
)
 
(66
)
Income before income taxes
6,724

 
3,388

 
17,007

 
4,970

Provision for income taxes
2,601

 
283

 
6,566

 
639

Net income
$
4,123

 
$
3,105

 
$
10,441

 
$
4,331

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.12

 
$
0.09

 
$
0.31

 
$
0.13

Diluted
$
0.11

 
$
0.08

 
$
0.27

 
$
0.12

Weighted average shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
34,119

 
33,120

 
33,967

 
32,820

Diluted
37,938

 
37,080

 
38,202

 
37,006


See accompanying Notes to Condensed Consolidated Financial Statements


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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
4,123

 
$
3,105

 
$
10,441

 
$
4,331

Available-for-sale investments:
 
 
 
 
 
 
 
Change in net unrealized gain (loss) on investments, net of tax
15

 
(44
)
 
25

 
(11
)
Less: reclassification adjustment for net realized gain (loss) included in net income
(5
)
 
(27
)
 
2

 
(28
)
Net change, net of tax
10

 
(71
)
 
27

 
(39
)
Other comprehensive income (loss), net
10

 
(71
)
 
27

 
(39
)
Comprehensive income
$
4,133

 
$
3,034

 
$
10,468

 
$
4,292


See accompanying Notes to Condensed Consolidated Financial Statements




5

Table of Contents

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


 
Nine Months Ended
 
September 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
10,441

 
$
4,331

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
10,424

 
8,826

Bad debt expense
629

 
346

Loss on disposal of property and equipment
9

 
1

Stock-based compensation
12,678

 
7,100

Amortization of premiums and accretion of discounts on investments
429

 
427

Excess tax benefits from stock-based compensation
(315
)
 
(131
)
Deferred income taxes
5,105

 
(47
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(5,512
)
 
(2,042
)
Prepaid expenses and other assets
(2,143
)
 
(1,177
)
Accounts payable
(3,606
)
 
(32
)
Accrued liabilities
2,735

 
236

Deferred revenues
10,612

 
6,907

Other noncurrent liabilities
182

 
117

Net cash provided by operating activities
41,668

 
24,862

Cash flows from investing activities:
 
 
 
Purchases of investments
(88,694
)
 
(117,279
)
Sales and maturities of investments
73,340

 
144,218

Purchases of property and equipment
(14,865
)
 
(10,196
)
Capitalized software development costs
(99
)
 

Net cash provided by (used in) investing activities
(30,318
)
 
16,743

Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
6,594

 
5,012

Excess tax benefits from stock-based compensation
315

 
131

Principal payments under capital lease obligations

 
(805
)
Net cash provided by financing activities
6,909

 
4,338

Effect of exchange rate changes on cash and cash equivalents

 
(27
)
Net increase in cash and cash equivalents
18,259

 
45,916

Cash and cash equivalents at beginning of period
76,504

 
42,369

Cash and cash equivalents at end of period
$
94,763

 
$
88,285

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Vesting of early exercised common stock options
$
16

 
$
41


See accompanying Notes to Condensed Consolidated Financial Statements



6

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

    
NOTE 1.
The Company and Summary of Significant Accounting Policies

Description of Business
Qualys, Inc. (the “Company”) was incorporated in the state of Delaware on December 30, 1999. The Company is headquartered in Redwood City, California and has majority-owned subsidiaries throughout the world. The Company is a pioneer and leading provider of cloud-based security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations. The Company’s cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Organizations can use the Company’s integrated suite of solutions delivered on its 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 and nine month periods ended September 30, 2015 are 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 from operations or net income.
 
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated upon consolidation.

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 and nine month periods ended September 30, 2014 presented in the accompanying condensed consolidated financial statements (in thousands, except per share data):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2014
 
as reported
 
as adjusted
 
as reported
 
as adjusted
Condensed Consolidated Statements of Operations:
 
 
 
 
 
 
 
Other income (expense), net
$
(141
)
 
$
(244
)
 
$
(279
)
 
$
(422
)
Total other income (expense), net
(16
)
 
(119
)
 
77

 
(66
)
Net income
3,208

 
3,105

 
4,474

 
4,331

Net income per share:
 
 
 
 
 
 
 
Basic
0.10

 
0.09

 
0.14

 
0.13

Diluted
0.09

 
0.08

 
0.12

 
0.12

 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income:
 
 
 
 
 
 
 
Change in foreign currency translation loss, net of tax
(101
)
 

 
(142
)
 

Comprehensive income
3,034

 
3,034

 
4,292

 
4,292



 
Nine Months Ended
 
September 30, 2014
 
as reported
 
as adjusted
Condensed Consolidated Statements of Cash Flows:
 
 
 
Net cash provided by operating activities
$
25,085

 
$
24,862

Net cash provided by investing activities
16,687

 
16,743

Effect of exchange rate changes on cash and cash equivalents
(228
)
 
(27
)
Net increase in cash and cash equivalents
45,916

 
45,916



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


8

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

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

Concentration of Credit Risk

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

Credit risk with respect to accounts receivable is dispersed due to the large number of customers. 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. One channel partner accounted for more than 10% of the Company's accounts receivable balance as of September 30, 2015. As of 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, 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.

Software Development Costs

The Company capitalizes qualifying software costs developed or obtained for internal use. These costs generally include internal costs, such as payroll and benefits of those employees directly associated with the development of the software, and other consulting expenses. Total capitalized development costs are $0.4 million at September 30, 2015 and December 31, 2014.

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


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

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. In August 2015, the FASB issued an ASU to defer the effective date of ASU 2014-09 for all entities by one year. Thus, 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 only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with 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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Table of Contents
Qualys, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

NOTE 2.
Fair Value of Financial Instruments

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

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



11

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:

 
 
September 30, 2015
  
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
 
 
(in thousands)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
48,907

 
$

 
$

 
$
48,907

Money market funds
 
3,612

 

 

 
3,612

U.S. government agencies
 
2,400

 

 

 
2,400

Commercial paper
 
39,841

 
3

 

 
39,844

Total
 
94,760

 
3

 

 
94,763

Short-term investments:
 
 
 
 
 
 
 
 
Commercial paper
 
24,579

 
9

 

 
24,588

Corporate bonds
 
12,561

 
2

 
(3
)
 
12,560

Asset-backed securities
 
537

 

 

 
537

U.S. government agencies
 
41,675

 
22

 

 
41,697

Total
 
79,352

 
33

 
(3
)
 
79,382

Long-term investments:
 
 
 
 
 
 
 
 
Asset-backed securities
 
6,405

 

 
(1
)
 
6,404

U.S. government agencies
 
12,461

 
9

 
(2
)
 
12,468

Corporate bonds
 
6,862

 
1

 
(3
)
 
6,860

Total
 
25,728

 
10

 
(6
)
 
25,732

Total
 
$
199,840

 
$
46

 
$
(9
)
 
$
199,877


 
 
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



12

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:

 
 
September 30, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$

 
$
64,432

 
$

 
$
64,432

U.S. government agencies
 

 
56,565

 

 
56,565

Corporate bonds
 

 
19,420

 

 
19,420

Asset-backed securities
 

 
6,941

 

 
6,941

Total
 
$

 
$
147,358

 
$

 
$
147,358


 
 
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


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

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

 
 
September 30, 2015
 
 
Mature within One Year
 
After One Year through Two Years
 
Over Two Years
 
Fair Value
 
 
(in thousands)
Commercial paper
 
$
64,432

 
$

 
$

 
$
64,432

U.S. government agencies
 
44,097

 
12,468

 

 
56,565

Corporate bonds
 
12,560

 
6,860

 

 
19,420

Asset-backed securities
 
537

 
4,203

 
2,201

 
6,941

Total
 
$
121,626

 
$
23,531

 
$
2,201

 
$
147,358



13

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

 
 
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 September 30, 2015, the Company had two outstanding forward contracts with notional amounts of 4.6 million Euros and 3.2 million British Pounds, which expired on October 31, 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 September 30, 2015 and December 31, 2014. The Company recorded a gain of $0.1 million from these forward contracts, which was offset by other foreign currency transaction losses of $0.4 million for the three months ended September 30, 2015. The Company recorded a net gain of $0.5 million, which was more than offset by other foreign currency transaction losses of $0.9 million during the nine months ended September 30, 2015. For the three months ended September 30, 2014, the Company recorded a gain of $0.5 million from these contracts, which were more than offset by other foreign currency losses of $0.8 million. For the nine months ended September 30, 2014, the Company recorded a gain of $0.4 million from these forward contracts, which were more than offset by losses of $0.7 million in other foreign currency transactions. These derivatives did not meet the criteria to be designated as hedges. These instruments were valued using Level 2 inputs.





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:
 
September 30,
 
December 31,
 
2015
 
2014
 
(in thousands)
Computer equipment
$
44,979

 
$
35,576

Computer software
12,524

 
10,899

Furniture, fixtures and equipment
2,831

 
2,931

Scanner appliances
21,380

 
19,861

Leasehold improvements
2,706

 
2,622

Total property and equipment
84,420

 
71,889

Less: accumulated depreciation and amortization
(54,455
)
 
(45,271
)
Property and equipment, net
$
29,965

 
$
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 $8.2 million and $6.0 million at September 30, 2015 and December 31, 2014, respectively, including assets that have not been placed in service of $0.9 million and $1.4 million, respectively. Other fixed assets not placed in service at September 30, 2015 and December 31, 2014, included in computer equipment and leasehold improvements, are approximately $1.7 million and $2.8 million, respectively. Depreciation and amortization expense relating to property and equipment was $3.7 million and $2.9 million for the three months ended September 30, 2015 and 2014, respectively and $10.1 million and $8.5 million for the nine months ended September 30, 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):
 
 
 
 
 
September 30, 2015
 
December 31, 2014
 
Estimated Lives
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Accumulated Amortization
 
Net Book Value
Existing technology
7 years
 
$
1,910

 
$
(1,388
)
 
$
522

 
$
(1,183
)
 
$
727

Patent license
14 years
 
1,388

 
(497
)
 
891

 
(422
)
 
966

Non-competition agreements and other
3 years
 
171

 
(171
)
 

 
(158
)
 
13

     Total intangibles subject to amortization
 
 
$
3,469

 
$
(2,056
)
 
1,413

 
$
(1,763
)
 
1,706

Intangible assets not subject to amortization
 
 
 
 
 
 
295

 
 
 
295

     Total intangible assets, net
 
 
 
 
 
 
$
1,708

 
 
 
$
2,001


Intangibles amortization expense was $0.1 million for the three months ended September 30, 2015 and 2014 and $0.3 million for the nine months ended September 30, 2015 and 2014.

As of September 30, 2015, the Company expects amortization expense in future periods to be as follows (in thousands):
Remainder of 2015
$
93

2016
373

2017
282

2018
100

2019
100

2020 and thereafter
465

Total expected future amortization expense
$
1,413


Goodwill, which is not subject to amortization, totaled $0.3 million as of September 30, 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 noncancellable operating leases for varying periods through 2019.

The following are the minimum annual lease payments due under operating leases at September 30, 2015:
 
Operating Leases
 
(in thousands)
Remainder of 2015
$
1,143

2016
3,577

2017
2,052

2018
601

2019
201

Total minimum lease payments
$
7,574


Rent expense was $1.6 million for each of the three months ended September 30, 2015 and 2014, and $4.8 million and $4.6 million for the nine months ended September 30, 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 September 30, 2015 and December 31, 2014, the Company has accrued $0.6 million and $0.5 million of deferred rent, respectively, related to these agreements, which is reflected in accrued liabilities and other noncurrent liabilities in the accompanying condensed consolidated balance sheets.

In October 2015, the Company entered into a new five-year office lease, which has a total minimum lease commitment of approximately $1.7 million.
   


17

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

Sales and Other Taxes

The Company’s software-as-a-service solutions are subject to sales and other taxes in certain jurisdictions where the Company does business. The Company bills sales and other taxes to customers and remits these amounts to the respective government authorities. For those jurisdictions where the Company has not yet billed sales tax to its customers and believes it is probable it may have exposure and can reasonably estimate such exposure, it has recorded a liability of $0.4 million and $0.5 million at September 30, 2015 and December 31, 2014, respectively, which is recorded within accrued liabilities in the condensed consolidated balance sheets. However, taxing jurisdictions have differing rules and regulations, which are subject to varying interpretations that may change over time. Other than the liability that the Company has accrued in its condensed consolidated balance sheets, the Company has been unable to assess the probability, or estimate the amount, of its sales tax exposure, if any. There are no pending reviews at September 30, 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.

Contingencies
From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a liability for such matters when it is probable a loss has been incurred and such loss can be reasonably estimated. At September 30, 2015, the Company has not recorded any material liabilities in accordance with accounting for contingencies.




18

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

NOTE 6.
Stock-based Compensation

Equity Incentive Plans
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 September 30, 2015, 1,848,947 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.

Stock Options
Employee Stock-based Compensation

Stock-based compensation for employee option awards is included in the condensed consolidated statements of operations as follows:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Cost of revenues
$
333

 
$
175

 
$
1,005

 
$
482

Research and development
1,294

 
599

 
3,584

 
1,544

Sales and marketing
1,015

 
561

 
2,806

 
1,839

General and administrative
1,674

 
1,050

 
4,612

 
2,815

Total employee stock-based compensation
$
4,316

 
$
2,385

 
$
12,007

 
$
6,680


Compensation cost is recognized on a straight-line basis over the service period. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

As of September 30, 2015, the Company had $26.3 million of total unrecognized employee compensation cost related to unvested option awards that it expects to recognize over a weighted-average period of 2.2 years.



19

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

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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Expected term (in years)
4.9 to 5.9
 
5.3 to 5.9
 
4.9 to 5.9
 
5.3 to 5.9
Volatility
45% to 46%
 
48% to 50%
 
45% to 48%
 
48% to 52%
Risk-free interest rate
1.62%
 
1.67%
 
1.3% to 1.65%
 
1.52% to 1.67%
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 declared 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 expense was a reduction to expense of $0.1 million and an expense of $0.1 million for the three months ended September 30, 2015 and 2014, respectively, and expense of $0.5 million and $0.4 million, for the nine months ended September 30, 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
1,113,950

 
41.17

 
 
 
 
Exercised
(567,227
)
 
11.63

 
 
 
 
Canceled
(560,025
)
 
26.69

 
 
 
 
September 30, 2015
7,592,105

 
16.16

 
6.1
 
107,966

Vested and expected to vest - September 30, 2015
7,130,958

 
15.00

 
5.9
 
106,964

Exercisable - September 30, 2015
5,073,823

 
8.79

 
4.9
 
99,803


Restricted Stock Units and Restricted Stock Awards

The terms and conditions of RSUs and RSAs, including vesting criteria and timing are set by the board of directors. The cost of RSUs and 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.



20

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

During the three months ended September 30, 2015, the Company granted 60,000 units of restricted stock with a grant price of $37.28 per unit and monthly vesting over a 2 year period. Compensation expense was $0.2 million for the three months ended September 30, 2015. The Company did not issue restricted stock units in the nine months ended September 30, 2014.

During the nine months ended September 30, 2014, the Company granted 2,401 shares of restricted stock, which vested immediately and had no further restrictions or service period, and resulted in compensation expense of $51,000. The Company did not issue restricted stock awards during the nine months ended September 30, 2015.


NOTE 7.
Other Income (Expense), Net

Other income (expense), net consists of the following:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Foreign exchange gain (loss)
$
(268
)
 
$
(217
)
 
$
(392
)
 
$
(342
)
Other income (expense)
(39
)
 
(27
)
 
(93
)
 
(80
)
Other income (expense), net
$
(307
)
 
$
(244
)
 
$
(485
)
 
$
(422
)



NOTE 8.
Income Taxes

The Company recorded a tax provision of $6.6 million and $0.6 million for the nine months ended September 30, 2015 and 2014, respectively. The increase in the tax provision recorded for the nine month period ended September 30, 2015 is primarily due to 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 rate was approximately 38.6 % in the nine months ended September 30, 2015.

As of September 30, 2015, the Company had unrecognized tax benefits of $3.5 million, of which $2.2 million, if recognized, would favorably impact the Company's effective tax rate. As of 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.




21

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

NOTE 9.
Segment Information and Information about Geographic Area

The Company operates in one segment. The Company’s chief operating decision maker is the Chairman, President and Chief Executive Officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis. All of the Company’s principal operations and decision-making functions are located in the United States. Revenues by geographic area, based on the location of the customer, are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
United States
$
29,993

 
$
24,038

 
$
84,463

 
$
67,948

Other
12,476

 
10,310

 
35,376

 
29,058

Total revenues
$
42,469

 
$
34,348

 
$
119,839

 
$
97,006



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

 
September 30,
 
December 31,
 
2015
 
2014
 
(in thousands)
United States
$
25,028

 
$
23,650

Other
4,937

 
2,968

Total property and equipment, net
$
29,965

 
$
26,618




22

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

NOTE 10.
Net Income Per Share

The computations for basic and diluted net income per share are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands, except per share data)
Numerator:
 
 
 
 
 
 
 
Net income
$
4,123

 
$
3,105

 
$
10,441

 
$
4,331

Denominator:
 
 
 
 
 
 
 
Weighted-average shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
34,119

 
33,120

 
33,967

 
32,820

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Common stock options
3,819

 
3,960

 
4,235

 
4,186

Diluted
37,938

 
37,080

 
38,202

 
37,006

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.12

 
$
0.09

 
$
0.31

 
$
0.13

Diluted
$
0.11

 
$
0.08

 
$
0.27

 
$
0.12


Potentially dilutive securities not included in the calculation of diluted net income per share because doing so would be antidilutive are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Common stock options
1,889

 
1,813

 
1,409

 
1,483





23

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.




24

Table of Contents

Overview

We are a pioneer and leading provider of cloud-based security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations. Our cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Our integrated suite of security and compliance solutions delivered on our QualysGuard Cloud Platform enables our customers to identify their IT assets, collect and analyze large amounts of IT security data, discover and prioritize vulnerabilities, recommend remediation actions and verify the implementation of such actions. Organizations use our integrated suite of solutions delivered on our QualysGuard Cloud Platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures.

We were founded 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 82% of total revenues for the nine months ended September 30, 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. In 2015, we introduced our Cloud Agent Platform, which provides customers with the ability to secure IT assets on a continuous basis regardless of where they reside, inside the enterprise, in the cloud or mobile endpoints.

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

We market and sell our solutions to enterprises, government entities and to small and medium-sized businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities. In the nine month periods ended September 30, 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 $119.8 million in the nine months ended September 30, 2015 from $97.0 million for the comparable period in 2014, representing an increase of $22.8 million or 24%.



25

Table of Contents

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
 (in thousands, except percentages)
Adjusted EBITDA
$
15,137

 
$
9,045

 
$
40,212

 
$
20,962

Percentage of revenues
36
%
 
26
%
 
34
%
 
22
%

 
Nine Months Ended
 
September 30,
 
2015
 
2014
 
 (in thousands)
Free cash flow
$
26,704

 
$
14,666



Adjusted EBITDA

We monitor Adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that Adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude in Adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that Adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. We calculate Adjusted EBITDA as net income before (1) other (income) expense, net, which includes interest income, interest expense and other income and expense, (2) provision for income taxes, (3) depreciation and amortization of property and equipment, (4) amortization of intangible assets and (5) stock-based compensation.



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The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for the three and nine months ended September 30, 2015 and 2014:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
 (in thousands)
Net income (1)
$
4,123

 
$
3,105

 
$
10,441

 
$
4,331

Other (income) expense, net (1)
154

 
119

 
103

 
66

Provision for income taxes
2,601

 
283

 
6,566

 
639

Depreciation and amortization of property and equipment
3,741

 
2,946

 
10,131

 
8,532

Amortization of intangible assets
97

 
98

 
293

 
294

Stock-based compensation
4,421

 
2,494

 
12,678

 
7,100

Adjusted EBITDA
$
15,137

 
$
9,045

 
$
40,212

 
$
20,962


(1) Other income (expense) and net income for the three and nine months ended September 30, 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 provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:

 
 
Nine Months Ended
 
 
September 30,
 
 
2015
 
2014
 
 (in thousands)
Net cash provided by operating activities
 
$
41,668

 
$
24,862

Less:
 
 
 
 
Purchases of property and equipment
 
(14,865
)
 
(10,196
)
Capitalized software development costs
 
(99
)
 

Free cash flow
 
$
26,704

 
$
14,666






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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.



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 a majority of our customers have also purchased 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 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 as we support more customers and add more solutions and functionality to our platforms, which will increase the cost of revenues in absolute dollars.


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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.


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 significantly invest in additional sales personnel worldwide and also in more marketing programs to support 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, 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


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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 nine months ended September 30, 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 nine months ended September 30, 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 allowance on our U.S. federal and state net deferred tax assets in the first nine months of 2014. The provision for income taxes also includes changes to unrecognized tax benefits related to uncertain tax positions.



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Results of Operations
The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Condensed Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenues
$
42,469

 
$
34,348

 
$
119,839

 
$
97,006

Cost of revenues (1)
8,762

 
7,421

 
24,883

 
21,442

Gross profit
33,707

 
26,927

 
94,956

 
75,564

Operating expenses:
 
 
 
 
 
 
 
Research and development (1)
7,564

 
6,490

 
21,919

 
19,305

Sales and marketing (1)
12,282

 
11,774

 
36,501

 
36,111

General and administrative (1)
6,983

 
5,156

 
19,426

 
15,112

Total operating expenses
26,829

 
23,420

 
77,846

 
70,528

Income from operations
6,878

 
3,507

 
17,110


5,036

Other income (expense), net (2)
(154
)
 
(119
)
 
(103
)
 
(66
)
Income before income taxes (2)
6,724

 
3,388

 
17,007

 
4,970

Provision for income taxes
2,601

 
283

 
6,566

 
639

Net income (2)
$
4,123

 
$
3,105

 
$
10,441

 
$
4,331




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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Cost of revenues
$
333

 
$
175

 
$
1,005

 
$
482

Research and development
1,294

 
599

 
3,584

 
1,551

Sales and marketing
1,015

 
561

 
2,806

 
1,852

General and administrative
1,779

 
1,159

 
5,283

 
3,215

Total stock-based compensation
$
4,421

 
$
2,494

 
$
12,678

 
$
7,100



(2) Other income (expense), net, income before income taxes, and net income for the three and nine months ended September 30, 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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Table of Contents

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

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Revenues
100
%
 
100
%
 
100
%
 
100
%
Cost of revenues
21

 
22

 
21

 
22

Gross profit
79

 
78


79


78

Operating expenses:
 
 
 
 
 
 
 
Research and development
18

 
19

 
18

 
20

Sales and marketing
29

 
34

 
30

 
37

General and administrative
16

 
15

 
17

 
16

Total operating expenses
63

 
68


65


73

Income from operations
16

 
10


14


5

Other income (expense), net
0

 
0

 
0

 
0

Income before income taxes
16

 
10


14


5

Provision for income taxes
6

 
1

 
5

 
1

Net income
10
%
 
9
%

9
%

4
%

Comparison of Three Months Ended September 30, 2015 and 2014
Revenues
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Revenues
$
42,469

 
$
34,348

 
$
8,121

 
24
%

Revenues increased $8.1 million for the three months ended September 30, 2015 compared to the three months ended September 30, 2014, primarily due to new customer subscriptions entered into after September 30, 2014 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $8.1 million, $6.0 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 demand for our existing and newer solutions.



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Cost of Revenues
 
Three Months Ended
 
 
 
 
 
September 30,
 
Change
 
2015
 
2014
 
$
 
%
 
(in thousands, except percentages)
Cost of revenues
$
8,762

 
$
7,421

 
$
1,341

 
18
%
Percentage of revenues
21
%
 
22
%
 
 
 
 
Gross profit percentage
79
%
 
78
%