QUALYS, INC. 10-Q

Item 1. Financial Statements   Qualys, Inc.   CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except share and per share data)       September 30,     December 31,       2020     2019   Assets                 Current assets:                 Cash and cash equivalents   $ 93,027     $ 87,559   Short-term marketable securities     225,734       211,331   Accounts receivable, net of allowance of $ 664 and $ 585 as of September 30, 2020 and December 31, 2019, respectively     64,291       78,034   Prepaid expenses and other current assets     22,480       18,692   Total current assets     405,532       395,616   Long-term marketable securities     133,260       119,508   Property and equipment, net     67,574       60,579   Operating leases - right of use asset     47,985       40,551   Deferred tax assets, net     13,581       18,830   Intangible assets, net     13,651       16,795   Goodwill     7,447       7,447   Restricted cash     1,200       1,200   Other noncurrent assets     16,854       15,082   Total assets   $ 707,084     $ 675,608   Liabilities and Stockholders’ Equity                 Current liabilities:                 Accounts payable   $ 2,223     $ 848   Accrued liabilities     24,772       22,784   Deferred revenues, current     200,283       192,172   Operating lease liabilities, current     11,777       7,663   Total current liabilities     239,055       223,467   Deferred revenues, noncurrent     19,157       20,935   Operating lease liabilities, noncurrent     48,392       44,015   Other noncurrent liabilities     181       388   Total liabilities     306,785       288,805   Commitments and contingencies (Note 9)                     Stockholders’ equity:                 Preferred stock, $ 0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at September 30, 2020 and December 31, 2019     —       —   Common stock, $ 0.001 par value; 1,000,000,000 shares authorized; 39,119,169 and 39,146,272 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively     39       39   Additional paid-in capital     388,814       362,408   Accumulated other comprehensive income     1,075       1,162   Retained earnings     10,371       23,194   Total stockholders’ equity     400,299       386,803   Total liabilities and stockholders’ equity   $ 707,084     $ 675,608     The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.   3 Table of Contents     Qualys, Inc. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (in thousands, except per share data)       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019   Revenues   $ 93,069     $ 82,671     $ 268,162     $ 236,943   Cost of revenues     20,619       17,108       58,005       52,354   Gross profit     72,450       65,563       210,157       184,589   Operating expenses:                                 Research and development     17,864       16,899       53,905       50,431   Sales and marketing     16,060       17,009       50,073       51,489   General and administrative     12,223       9,106       33,937       29,961   Total operating expenses     46,147       43,014       137,915       131,881   Income from operations     26,303       22,549       72,242       52,708   Other income (expense), net:                                 Interest expense     ( 1 )     ( 28 )     ( 4 )     ( 98 ) Interest income     1,123       2,142       4,439       6,391   Other income (expense), net     209       ( 328 )     268       ( 320 ) Total other income, net     1,331       1,786       4,703       5,973   Income before income taxes     27,634       24,335       76,945       58,681   Provision for income taxes     4,891       5,161       9,189       10,009   Net income   $ 22,743     $ 19,174     $ 67,756     $ 48,672   Net income per share:                                 Basic   $ 0.58     $ 0.49     $ 1.73     $ 1.24   Diluted   $ 0.56     $ 0.47     $ 1.66     $ 1.17   Weighted average shares used in computing net income per share:                                 Basic     39,238       39,014       39,171       39,099   Diluted     40,764       41,162       40,907       41,447       The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.   4 Table of Contents     Qualys, Inc. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited) (in thousands)       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019   Net income   $ 22,743     $ 19,174     $ 67,756     $ 48,672   Other comprehensive income (loss):                                 Available-for-sale debt securities:                                 Changes in net unrealized gains (losses), net of tax effects of $ 183 and ($ 6 ) in the three months ended September 30, 2020 and 2019, respectively, and ($ 245 ) and ($ 257 ) in the nine months ended September 30, 2020 and 2019, respectively.     ( 619 )     40       825       1,419   Reclassification adjustments for net realized (gains) losses included in net income, net of tax effects of ($ 32 ) and $ 0 in the three months ended September 30, 2020 and 2019, respectively, and ($ 2 ) and ($ 6 ) in the nine months ended September 30, 2020 and 2019, respectively.     108       ( 18 )     8       25   Total changes in unrealized gains (losses) on marketable securities, net of tax     ( 511 )     22       833       1,444   Cash flow hedges:                                 Changes in net unrealized gains (losses), net of tax effects of $ 213 and ($ 313 ) in the three months ended September 30, 2020 and 2019, respectively, and $ 152 and ($ 404 ) in the nine months ended September 30, 2020 and 2019, respectively.     ( 718 )     1,072       ( 510 )     1,423   Reclassification adjustments for net realized (gains) losses included in net income, net of tax effects of $ 39 and $ 16 in the three months ended September 30, 2020 and 2019, respectively, and $ 121 and $ 0 in the nine months ended September 30, 2020 and 2019, respectively.     ( 131 )     ( 63 )     ( 410 )     ( 10 ) Total changes in unrealized gains (losses) on cash flow hedges, net of tax     ( 849 )     1,009       ( 920 )     1,413   Other comprehensive income (loss), net of tax     ( 1,360 )     1,031       ( 87 )     2,857   Comprehensive income   $ 21,383     $ 20,205     $ 67,669     $ 51,529     The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.   5 Table of Contents     Qualys, Inc. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands)       Nine Months Ended       September 30,       2020     2019   Cash flow from operating activities:                 Net income   $ 67,756     $ 48,672   Adjustments to reconcile net income to net cash provided by operating activities:                 Depreciation and amortization expense     23,975       23,486   Bad debt expense     392       156   Loss on disposal of property and equipment     9       196   Stock-based compensation     29,930       25,163   Amortization of premiums (accretion of discounts) on marketable securities     163       ( 1,402 ) Deferred income taxes     5,061       7,296   Changes in operating assets and liabilities:                 Accounts receivable     13,351       14,355   Prepaid expenses and other assets     ( 6,071 )     ( 6,568 ) Accounts payable     326       ( 1,336 ) Accrued liabilities     72       1,518   Deferred revenues     6,333       15,413   Net cash provided by operating activities     141,297       126,949   Cash flow from investing activities:                 Purchases of marketable securities     ( 290,534 )     ( 259,286 ) Sales and maturities of marketable securities     263,296       263,874   Purchases of property and equipment     ( 22,742 )     ( 19,473 ) Acquisition of businesses, net of cash acquired, and purchases of intangible assets     ( 1,500 )     ( 1,850 ) Purchase of privately-held investment     —       ( 625 ) Net cash used in investing activities     ( 51,480 )     ( 17,360 ) Cash flow from financing activities:                 Repurchases of common stock     ( 91,881 )     ( 73,877 ) Proceeds from exercise of stock options     23,962       11,014   Payments for taxes related to net share settlement of equity awards     ( 16,338 )     ( 10,864 ) Principal payments under finance lease obligations     ( 92 )     ( 1,273 ) Net cash used in financing activities     ( 84,349 )     ( 75,000 ) Net increase in cash, cash equivalents and restricted cash     5,468       34,589   Cash, cash equivalents and restricted cash at beginning of period     88,759       42,226   Cash, cash equivalents and restricted cash at end of period   $ 94,227     $ 76,815     The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.   6 Table of Contents     Qualys, Inc. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY   (unaudited) (in thousands, except share data)                               Accumulated                       Common Stock     Additional     Other             Total                       Paid-In     Comprehensive     Retained     Stockholders’       Shares     Amount     Capital     Income     Earnings     Equity   Balances at December 31, 2019     39,146,272     $ 39     $ 362,408     $ 1,162     $ 23,194     $ 386,803   Net income     —       —       —       —       18,694       18,694   Other comprehensive income, net of tax     —       —       —       391       —       391   Issuance of common stock upon exercise of stock options     144,989       —       4,714       —       —       4,714   Repurchase of common stock     ( 346,250 )     —       ( 4,160 )     —       ( 24,766 )     ( 28,926 ) Issuance of common stock upon vesting of restricted stock units     138,260       —       —       —       —       —   Taxes related to net share settlement of equity awards     ( 58,598 )     —       ( 5,000 )     —       —       ( 5,000 ) Stock-based compensation     —       —       10,054       —       —       10,054   Balances at March 31, 2020     39,024,673       39       368,016       1,553       17,122       386,730   Net income     —       —       —       —       26,319       26,319   Other comprehensive income, net of tax     —       —       —       882             882   Issuance of common stock upon exercise of stock options     448,056       1       15,715       —       —       15,716   Repurchase of common stock     ( 242,500 )     ( 1 )     ( 2,912 )     —       ( 22,343 )     ( 25,256 ) Issuance of common stock upon vesting of restricted stock units     146,343       —             —       —       —   Taxes related to net share settlement of equity awards     ( 61,235 )     —       ( 6,115 )     —       —       ( 6,115 ) Stock-based compensation     —       —       9,498       —       —       9,498   Balances at June 30, 2020     39,315,337       39       384,202       2,435       21,098       407,774   Net income     —       —       —       —       22,743       22,743   Other comprehensive income, net of tax     —       —       —       ( 1,360 )     —       ( 1,360 ) Issuance of common stock upon exercise of stock options     102,254       —       3,532       —       —       3,532   Repurchase of common stock     ( 352,000 )     —       ( 4,229 )     —       ( 33,470 )     ( 37,699 ) Issuance of common stock upon vesting of restricted stock units     97,408       —       —       —       —       —   Taxes related to net share settlement of equity awards     ( 43,830 )     —       ( 5,223 )     —       —       ( 5,223 ) Stock-based compensation     —       —       10,532       —       —       10,532   Balances at September 30, 2020     39,119,169     $ 39     $ 388,814     $ 1,075     $ 10,371     $ 400,299     7 Table of Contents   Qualys, Inc. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY   (unaudited) (in thousands, except share data)                               Accumulated                       Common Stock     Additional     Other             Total                       Paid-In     Comprehensive     Retained     Stockholders’       Shares     Amount     Capital     Income     Earnings     Equity   Balances at December 31, 2018     39,015,034     $ 39     $ 330,572     $ ( 586 )   $ 27,964     $ 357,989   Net income     —       —       —       —       13,266       13,266   Other comprehensive income, net of tax     —       —       —       896       —       896   Issuance of common stock upon exercise of stock options     152,164       —       4,047       —       —       4,047   Repurchase of common stock     ( 94,090 )     —       ( 1,129 )     —       ( 6,742 )     ( 7,871 ) Issuance of common stock upon vesting of restricted stock units     99,601       —       —       —       —       —   Taxes related to net share settlement of equity awards     ( 38,877 )     —       ( 3,367 )     —       —       ( 3,367 ) Stock-based compensation     —       —       8,443       —       —       8,443   Balances at March 31, 2019     39,133,832       39       338,566       310       34,488       373,403   Net income     —       —       —       —       16,232       16,232   Other comprehensive income, net of tax             —       —       930       —       930   Issuance of common stock upon exercise of stock options     192,687       —       4,944       —       —       4,944   Repurchase of common stock     ( 183,948 )     —       ( 2,207 )     —       ( 14,038 )     ( 16,245 ) Issuance of common stock upon vesting of restricted stock units     126,754       —       —       —       —       —   Taxes related to net share settlement of equity awards     ( 45,250 )     —       ( 4,044 )     —       —       ( 4,044 ) Stock-based compensation     —       —       8,378       —       —       8,378   Balances at June 30, 2019     39,224,075       39       345,637       1,240       36,682       383,598   Net income     —       —       —       —       19,174       19,174   Other comprehensive income, net of tax     —       —       —       1,031       —       1,031   Issuance of common stock upon exercise of stock options     68,059       —       2,023       —       —       2,023   Repurchase of common stock     ( 603,417 )     —       ( 7,240 )     —       ( 42,521 )     ( 49,761 ) Issuance of common stock upon vesting of restricted stock units     103,206       —       —       —       —       —   Taxes related to net share settlement of equity awards     ( 41,120 )     —       ( 3,453 )     —       —       ( 3,453 ) Stock-based compensation     —       —       8,411       —       —       8,411   Balances at September 30, 2019     38,750,803     $ 39     $ 345,378     $ 2,271     $ 13,335     $ 361,023     The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.   8 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”, "we", "us", "our") was incorporated in the state of Delaware on December 30, 1999. The Company is headquartered in Foster City, California and has wholly-owned subsidiaries throughout the world. The Company is a pioneer and leading provider of cloud-based information technology ("IT"), security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations. The Company’s cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Organizations can use the Company’s integrated suite of solutions delivered on its Qualys Cloud Platform to cost-effectively obtain a unified view of their security and compliance posture across globally distributed IT infrastructures.   Basis of Presentation   The accompanying unaudited condensed consolidated financial statements and condensed footnotes have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial information as well as the instructions to Form 10 -Q and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Certain information and disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet as of December 31, 2019 , included herein, was derived from the audited financial statements as of that date but does not include all disclosures, including notes required by U.S. GAAP. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results of operations expected for the entire year ending December  31, 2020 or for any other future annual or interim periods. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10 -K for the year ended December 31, 2019 , filed with the SEC on February 21, 2020.   Risks and Uncertainties   In March 2020, the World Health Organization declared the outbreak of a novel strain of coronavirus (“COVID- 19” ) as a pandemic. As a result of COVID- 19, the Company has modified certain aspects of its business, including restricting employee travel, requiring employees to work from home, and canceling certain events and meetings, among other modifications. The Company will continue to actively monitor the situation and may take further actions that alter its business operations as may be required by federal, state or local authorities or that the Company determines are in the best interests of its employees, customers, partners, suppliers and stockholders. While the Company has not incurred significant disruptions from the COVID- 19 outbreak, the Company is unable to accurately predict the full impact that COVID- 19 will have due to numerous uncertainties, including the duration of the outbreak, actions that may be taken by governmental authorities and the impact to the business of its customers and partners. The Company will continue to evaluate the nature and extent of the impact to its business, financial position, results of operations and cash flows.   Use of Estimates   The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date of the condensed consolidated financial statements and the reported results of operations during the reporting period. The Company’s management regularly assesses these estimates, which primarily affect revenue recognition, the valuation of accounts receivable, goodwill and intangible assets, capitalization of internally developed software, stock-based compensation and the provision for income taxes. Actual results could differ from those estimates and such differences may be material to the accompanying unaudited condensed consolidated financial statements.   9 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   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 net asset positions, to date primarily cash, accounts receivable and operating lease liabilities, as well as to manage foreign currency fluctuation risk related to forecasted transactions. Open contracts are recorded within prepaid expenses and other current assets, other noncurrent assets, accrued liabilities or other noncurrent liabilities in the condensed consolidated balance sheets. Gains and losses resulting from currency exchange rate movements on non-designated forward contracts are recognized in other income (expense), net. Any gains or losses from derivatives designated as cash flow hedges are first recorded within accumulated other comprehensive income ("AOCI") and then reclassified into revenue or operating expenses when the hedged item impacts the condensed consolidated statements of operations.   Stock-Based Compensation   The Company recognizes the fair value of its employee stock options and restricted stock units over the requisite service periods for those awards ultimately expected to vest. The fair value of each option is estimated on the date of grant using the Black-Scholes-Merton option pricing model and the fair value of each restricted stock unit ("RSU") is based on the price of the Company's stock on the date of grant. Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from original estimates.   The Company has issued performance-based awards and stock options, and accounts for these awards and options as stock-based compensation with multiple performance conditions. For these performance-based awards, the Company records compensation expense for only the performance milestones that are probable of being achieved, with such expense recorded on a straight-line basis over the expected vesting period. The Company reassesses performance-based estimates each reporting period and if there are any changes in the probability of achievement, the Company recognizes the cumulative effect in the period when the estimate changes.   Non-Marketable Securities   During the fiscal year ended December 31, 2018 , the Company invested $ 2.5 million in preferred stock of a privately-held company. The fair value of the investment is not readily available, and there are no quoted market prices for the investment. The investment is included in other noncurrent assets on the condensed consolidated balance sheets and measured at cost less impairment, adjusted for observable price changes. The investment is assessed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. During the second quarter ended June 30, 2019, the Company made an advance payment of $ 0.6 million to the investee for certain development work, which is recorded in other noncurrent assets on the condensed consolidated balance sheet. During the third quarter ended  September 30, 2019 , the Company made an additional investment of $ 0.6 million in a convertible security issued by this investee and recorded it in other current assets on the condensed consolidated balance sheet. As of September 30, 2020 and December 31, 2019 , no impairment was recorded for the investments.   Recently Adopted Accounting Pronouncements   In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018 - 15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350 - 40 ): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs related to internal-use software. It also requires the Company to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The Company adopted this ASU prospectively to applicable implementation costs incurred since January 1, 2020. The adoption did not have a material impact on the Company's condensed consolidated financial statements.   In June 2016, the FASB issued ASU No. 2016 - 13, Financial Instruments-Credit Losses (Topic 326 ) as modified by subsequently issued ASU No. 2018 - 19, 2019 - 04 and 2019 - 05,  which introduces a new accounting model, Current Expected Credit Losses ("CECL"). CECL requires earlier recognition of credit losses, while also providing additional transparency about credit risk. CECL utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses at the time the financial asset is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The Company adopted this ASU on January 1, 2020, using a modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings to be recognized on the date of adoption with prior periods not restated. The adoption did not have a material impact on the Company's condensed consolidated financial statements.   10 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Recently Issued Accounting Pronouncements Not Yet Adopted   In January 2020, the FASB issued ASU No. 2020 - 01,  Investments—Equity Securities (Topic 321 ), Investments—Equity Method and Joint Ventures (Topic 323 ), and Derivatives and Hedging (Topic 815 ) ("ASU 2020 - 01" ). This ASU clarifies the interaction of the accounting for equity securities under Topic 321, the accounting for equity method investments in Topic 323, and the accounting for certain forward contracts and purchased options in Topic 815. It is effective for the Company beginning in the first quarter of fiscal 2021, and earlier adoption is permitted. The Company is currently evaluating the impact of its pending adoption of ASU 2020 - 01 on the Company's condensed consolidated financial statements.   In December 2019, the FASB issued ASU No. 2019 - 12, Simplifying the Accounting for Income Taxes ("ASU 2019 - 12" ), which simplifies the accounting for income taxes, eliminates certain exceptions within ASC 740, Income Taxes, and clarifies certain aspects of the current guidance to promote consistency among reporting entities. ASU 2019 - 12 is effective for the Company for fiscal years beginning after December 15, 2020. Most amendments within the standard are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. The Company is currently evaluating the impacts of the provisions of ASU 2019 - 12 on its condensed consolidated financial statements.     NOTE 2. Fair Value of Financial Instruments   Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For certain of the Company’s financial instruments, including certain cash equivalents, accounts receivable, accounts payable and other current liabilities, the carrying amounts approximate their fair values due to the relatively short maturity of these balances.   The Company measures and reports certain cash equivalents, marketable securities, derivative foreign currency forward contracts and commitments associated with prior business combinations at fair value in accordance with the provisions of the authoritative accounting guidance that addresses fair value measurements. This guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:   Level 1 -Valuations based on quoted prices in active markets for identical assets or liabilities.   Level 2 -Valuations based on other than quoted prices in active markets for identical assets or 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.   11 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   The Company's 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. During the fiscal years ended December 31, 2019 and 2018 , the Company made investments of $ 0.6 million in a convertible security and $ 2.5 million in preferred stock, respectively, issued by a privately-held company. The estimated fair value of the investments was determined based on Level 3 inputs. As of September 30, 2020 and December 31, 2019 , management estimated that the fair value of the investments equaled their carrying value.   The Company's cash and cash equivalents, and marketable securities consist of the following:       September 30, 2020               Unrealized     Unrealized               Amortized Cost     Gains     (Losses)     Fair Value       (in thousands)   Cash and cash equivalents:                                 Cash   $ 33,566     $ —     $ —     $ 33,566   Money market funds     58,511       —       —       58,511   Commercial paper     950       —       —       950   Total     93,027       —       —       93,027   Short-term marketable securities:                                 Commercial paper     649       —       —       649   Corporate bonds     30,508       249       ( 1 )     30,756   Asset-backed securities     5,514       25       —       5,539   U.S. government agencies     188,525       266       ( 1 )     188,790   Total     225,196       540       ( 2 )     225,734   Long-term marketable securities:                                 Asset-backed securities     40,367       290       —       40,657   U.S. government agencies     37,414       373       ( 2 )     37,785   Foreign government agencies     1,001       33       —       1,034   Corporate bonds     52,870       920       ( 6 )     53,784   Total     131,652       1,616       ( 8 )     133,260   Total   $ 449,875     $ 2,156     $ ( 10 )   $ 452,021         December 31, 2019               Unrealized     Unrealized               Amortized Cost     Gains     (Losses)     Fair Value       (in thousands)   Cash and cash equivalents:                                 Cash   $ 84,102     $ —     $ —     $ 84,102   Money market funds     58       —       —       58   Commercial paper     3,399       —       —       3,399   Total     87,559       —       —       87,559   Short-term marketable securities:                                 Commercial paper     2,239       —       —       2,239   Corporate bonds     33,048       51       ( 1 )     33,098   Asset-backed securities     2,438       11       —       2,449   U.S. government agencies     173,364       184       ( 3 )     173,545   Total     211,089       246       ( 4 )     211,331   Long-term marketable securities:                                 Asset-backed securities     40,001       193       ( 1 )     40,193   U.S. government agencies     46,447       370       —       46,817   Corporate bonds     32,236       262       —       32,498   Total     118,684       825       ( 1 )     119,508   Total   $ 417,332     $ 1,071     $ ( 5 )   $ 418,398     12 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   There were no marketable securities that had been in a continuous unrealized loss position for 12 months or longer. As of September 30, 2020 , the Company had the ability and intent to hold all marketable securities that were in an unrealized loss position until maturity or recovery. The Company considered the extent to which fair value was less than amortized cost basis and conditions related to security’s industry and geography and changes to the ratings, if any, and concluded the decline in fair value compared to carrying value was not related to credit loss.   The following table sets forth by level within the fair value hierarchy the fair value of the Company's cash equivalents and marketable securities measured on a recurring basis:       September 30, 2020       Level 1     Level 2     Fair Value       (in thousands)   Money market funds   $ 58,511     $ —     $ 58,511   Commercial paper     —       1,599       1,599   U.S. government agencies     —       226,575       226,575   Foreign government agencies     —       1,034       1,034   Corporate bonds     —       84,540       84,540   Asset-backed securities     —       46,196       46,196   Total   $ 58,511     $ 359,944     $ 418,455         December 31, 2019       Level 1     Level 2     Fair Value       (in thousands)   Money market funds   $ 58     $ —     $ 58   Commercial paper     —       5,638       5,638   U.S. government agencies     —       220,362       220,362   Corporate bonds     —       65,596       65,596   Asset-backed securities     —       42,642       42,642   Total   $ 58     $ 334,238     $ 334,296     There were no transfers between Level 1 and Level 2 of the fair value hierarchy, as determined at the end of each reporting period.   The following summarizes the fair value of marketable securities by contractual maturity as of September 30, 2020 and December 31, 2019 :       September 30, 2020       Mature within     Mature after One Year     Mature over               One Year     through Two Years     Two Years     Fair Value       (in thousands)   Commercial paper   $ 1,599     $ —     $ —     $ 1,599   U.S. government agencies     188,790       37,600       185       226,575   Foreign government agencies     —       —       1,034       1,034   Corporate bonds     30,756       33,505       20,279       84,540   Asset-backed securities     5,539       17,788       22,869       46,196   Total   $ 226,684     $ 88,893     $ 44,367     $ 359,944     13 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)       December 31, 2019       Mature within     Mature after One Year     Mature over               One Year     through Two Years     Two Years     Fair Value       (in thousands)   Commercial paper   $ 5,638     $ —     $ —     $ 5,638   U.S. government agencies     173,546       46,816       —       220,362   Corporate bonds     33,098       23,251       9,247       65,596   Asset-backed securities     2,449       15,550       24,643       42,642   Total   $ 214,731     $ 85,617     $ 33,890     $ 334,238     Derivative Financial Instruments   Designated cash flow hedges   The Company uses a hedging strategy to reduce its exposure to foreign currency exchange rate fluctuations for forecasted subscription renewals and new orders in British Pound ("GBP") and Euro. The Company uses forward currency contracts accounted for as cash flow hedges against a designated portion of forecasted subscription renewals and new orders. Unrealized foreign exchange gains or losses related to those designated cash flow hedge contracts are recorded in AOCI and will be reclassified into revenues in the same periods when the hedged contracts are recognized into revenues.   In addition, the Company uses a hedging strategy to reduce its exposure associated with costs incurred in Indian Rupee ("INR"). Unrealized foreign exchange gains or losses related to those designated cash flow hedge contracts are recorded in AOCI and will be reclassified into operating expenses when the associated hedged expenses are incurred.   At September 30, 2020 , the Company had 39 open designated cash flow hedge contracts with notional amounts of €22.5  million, £8.8   million and Rs. 1,745.0 million. At December 31, 2019 , the Company had 26 open designated cash flow hedge contracts with notional amounts of €24.2 million and £9.7 million.   The following table shows the gains and losses, before tax, of the Company's derivative instruments designated as cash flow hedges in AOCI and the condensed consolidated statements of operations for the three and nine months ended September 30, 2020 and 2019 :       Three Months Ended September 30,     Nine Months Ended September 30,   Derivative instruments designated as cash flow hedges:   2020     2019     2020     2019       (in thousands)   Net unrealized gains (losses) recognized in AOCI:                                 Foreign currency forward contracts (GBP, Euro and INR)   $ ( 931 )   $ 1,385     $ ( 662 )   $ 1,827                                     Net unrealized (gains) losses reclassified from AOCI into income:                                 Foreign currency forward contracts (GBP and Euro)     ( 297 )     ( 79 )     ( 873 )     ( 10 ) Foreign currency forward contracts (INR)     127       —       342       —   Net change in AOCI before tax   $ ( 1,101 )   $ 1,306     $ ( 1,193 )   $ 1,817     As of September 30, 2020 , the net amount of unrealized gains and losses on the foreign currency forward contracts for GBP and Euro reported in AOCI that is expected to be reclassified into revenue within the next  12 months is a loss of $ 0.5  million (before tax). As of September 30, 2020 , the net amount of unrealized gains and losses on the foreign currency forward contracts for INR reported in AOCI that is expected to be reclassified into operating expenses is a gain of $ 0.1  million (before tax).   14 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Non-designated forward contracts   At September 30, 2020 , the Company had 18  outstanding non-designated forward contracts with notional amounts of  €13.9  million, £8.0  million and Rs.173.6  million. At December 31, 2019 , the Company had 15 outstanding non-designated forward contracts with notional amounts of €20.0 million, £5.6 million and Rs.756.0 million.   The following summarizes derivative financial instruments as of September 30, 2020 and December 31, 2019 :       September 30,     December 31,       2020     2019   Assets   (in thousands)   Foreign currency forward contracts designated as cash flow hedge   $ 396     $ 427   Foreign currency forward contracts not designated as hedging instruments     292       515   Total   $ 688     $ 942   Liabilities                 Foreign currency forward contracts designated as cash flow hedge   $ ( 1,227 )   $ ( 524 ) Foreign currency forward contracts not designated as hedging instruments     ( 665 )     ( 550 ) Total   $ ( 1,892 )   $ ( 1,074 )   All foreign currency forward contracts were valued at fair value using Level 2 inputs.   The following summarizes the gains (losses) recognized from forward contracts and other foreign currency transactions in other income, net on the condensed consolidated statements of operations:       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands)   Net gains (losses) from non-designated forward contracts   $ ( 688 )   $ 642     $ ( 108 )   $ 708   Other foreign currency transactions gains (losses)     961       ( 906 )     565       ( 839 ) Total foreign exchange gains (losses), net     273       ( 264 )     457       ( 131 ) Other expenses     ( 64 )     ( 64 )     ( 189 )     ( 189 ) Other income (loss), net   $ 209     $ ( 328 )   $ 268     $ ( 320 )       NOTE 3. Accumulated Other Comprehensive Income   The components and changes in accumulated other comprehensive income, net of taxes, for the nine months ended September 30, 2020 and 2019 were as follows:       Unrealized     Unrealized               gains     gains (losses)               on AFS debt     on cash flow               securities     hedges     Total       (in thousands)   Balances as of December 31, 2019   $ 822     $ 340     $ 1,162   Other comprehensive income (loss) before reclassification     825       ( 510 )     315   Reclassification of (gains) losses from other comprehensive income     8       ( 410 )     ( 402 ) Total change in unrealized gains (losses), net of tax     833       ( 920 )     ( 87 ) Balances as of September 30, 2020   $ 1,655     $ ( 580 )   $ 1,075     15 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)       Unrealized     Unrealized               gains (losses)     gains (losses)               on AFS debt     on cash flow               securities     hedges     Total       (in thousands)   Balances as of December 31, 2018   $ ( 545 )   $ ( 41 )   $ ( 586 ) Other comprehensive income before reclassification     1,419       1,423       2,842   Reclassification of (gains) losses from other comprehensive income     25       ( 10 )     15   Total change in unrealized gains, net of tax     1,444       1,413       2,857   Balances as of September 30, 2019   $ 899     $ 1,372     $ 2,271         NOTE 4. Property and Equipment, Net   Property and equipment, net, which includes assets under finance leases, consists of the following:       September 30,     December 31,       2020     2019       (in thousands)   Computer equipment   $ 133,628     $ 112,599   Computer software     26,298       26,137   Furniture, fixtures and equipment     8,335       6,973   Finance leases - right of use asset     3,503       3,503   Scanner appliances     16,388       15,864   Leasehold improvements     21,043       18,817   Total property and equipment     209,195       183,893   Less: accumulated depreciation and amortization     ( 141,621 )     ( 123,314 ) Property and equipment, net   $ 67,574     $ 60,579     Physical scanner appliances and other computer equipment had a net carrying value of $ 7.4  million and $ 4.9 million at September 30, 2020 and December 31, 2019 , respectively, including assets that had not been placed in service of $ 3.7  million and $ 0.9  million, respectively. Depreciation and amortization expense relating to property and equipment, including assets under finance leases, was $ 6.7  million and $ 6.2  million for the three months ended September 30, 2020 and 2019 , respectively, and $ 19.3  million and $ 18.9  million for the nine months ended September 30, 2020 and 2019 , respectively.     NOTE 5. Revenue from Contracts with Customers   The Company's subscription contracts are typically satisfied ratably over the subscription term as its cloud-based offerings are delivered to customers electronically and over time. In addition, the Company recognizes revenues for certain limited scan arrangements on an as-used basis. The Company recognizes revenue related to professional services based on time and materials or completion of milestones stated in the contracts.   As the vast majority of the Company’s offerings are subscription based, the Company rarely needs to allocate the transaction price to separate performance obligations. In the rare case that allocation of the transaction price is needed, the Company recognizes revenue in proportion to the standalone selling prices ("SSP") of the underlying services at contract inception. If an SSP is not directly observable, the Company determines the SSP using information that may include market conditions and other observable inputs. The Company's transaction prices typically do not include variable consideration and are a fixed amount for a specific period of time, and the majority of contracts are twelve months with certain customers signing longer term deals. In general, the Company does not offer rights of return, performance bonuses, customer loyalty programs, payments via non-cash methods, refunds, volume rebates, incentive payments, penalties, price concessions or payments or discounts contingent on future events and the Company does not grant its customers any material rights. For contracts that include leased scanners and PCPs, the Company applies the lease and non-lease component practical expedient under ASC 842 to account for non-lease components and lease components as combined components under the revenue recognition guidance in ASU 2014 - 09, "Revenue from Contracts with Customers" (Topic 606 ) as the subscriptions are the predominant components in the arrangements.   16 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Costs of shipping and handling charges associated with physical scanner appliances and other computer equipment are included in cost of revenues. Sales taxes and other taxes collected from customers to be remitted to government authorities are excluded from revenues.   Incremental direct costs of obtaining a contract, which consist of sales commissions primarily for new business and upsells, are deferred and amortized over the estimated life of the customer relationship if renewals are expected and the renewal commission is not commensurate with the initial commission. The Company elected the practical expedient to expense commissions on renewals where the specific anticipated contract term amortization period is one year or less. The Company amortizes the capitalized commission cost as a selling expense on a straight-line basis over a period of five years. The Company classifies deferred commissions as current or noncurrent based on the timing of when it expects to recognize the expense. The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets and other noncurrent assets, respectively, in its condensed consolidated balance sheets.    Capitalized costs to obtain contracts, current and noncurrent are as follows:       September 30, 2020     December 31, 2019       (in thousands)   Commission asset, current   $ 3,213     $ 2,568   Commission asset, noncurrent   $ 6,783     $ 6,454     For the three months ended September 30, 2020 and 2019 , the Company recognized $ 0.8  million and $ 0.5 million, respectively, of commission expense from amortization of its commission assets. For the nine months ended September 30, 2020 and 2019 , the Company recognized $ 2.2  million and $ 1.4  million, respectively, of commission expense from amortization of its commission assets. During the same periods, there was no impairment loss related to capitalized costs.   The Company records deferred revenue when cash payments are received or due in advance of its performance offset by revenue recognized in the period. Revenue of $ 38.3  million and $ 31.3  million was recognized during the three months ended September 30, 2020 and 2019 , respectively, which amounts were included in the deferred revenue balances as of December 31, 2019 and 2018 , respectively. Revenue of $ 168.0  million and $ 144.6  million was recognized during the nine months ended September 30, 2020 and 2019 , respectively, which amounts were included in the deferred revenue balances as of December 31, 2019 and 2018 , respectively.   The Company's payment terms vary by the type and location of its customer and the products or services offered. For certain products or services and customer types, the Company requires payment before the products or services are delivered to the customer.   The following table sets forth the expected revenue from all remaining performance obligations as of September 30, 2020 :       Total Expected Revenue       (in thousands)   2020 (remaining three months)   $ 28,515   2021     82,348   2022     50,129   2023     18,779   2024     949   2025 and thereafter     406   Total   $ 181,126     17 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Revenues allocated to remaining performance obligations represents contracted revenues that have not yet been recognized, which include deferred revenue and the amounts that will be invoiced and recognized as revenues in future periods from open contracts. Remaining performance obligations represent the transaction price of noncancelable orders for which service has not been performed and excludes unexercised renewals. The Company applied the short-term contract exemption to exclude the remaining performance obligations that are part of a contract that has an original expected duration of one year or less.   From time to time, the Company enters into contracts with customers that extend beyond one year, with certain of its customers electing to pay for more than one year of services upon contract execution. For any discounts associated with these multiple year contracts, the Company concluded its contracts did not contain a financing component.   Revenues by sales channel are as follows:       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands)   Direct   $ 54,821     $ 47,997     $ 156,631     $ 136,708   Partner     38,248       34,674       111,531       100,235   Total   $ 93,069     $ 82,671     $ 268,162     $ 236,943     The Company utilizes partners to enable and accelerate the adoption of its cloud platform by increasing its distribution capabilities and market awareness of its cloud platform as well as by targeting geographic regions outside the reach of its direct sales force. The Company's channel partners maintain relationships with their customers throughout the territories in which they operate and provide their customers with services and third -party solutions to help meet those customers’ evolving security and compliance requirements. As such, these partners may offer the Company's IT, security and compliance solutions in conjunction with one or more of their own products or services and act as a conduit through which the Company can connect with these prospective customers to offer its solutions. For sales involving a channel partner, the channel partner engages with the prospective customer directly and involves the Company's sales team as needed to assist in developing and closing an order. When a channel partner secures a sale, the Company sells the associated subscription to the channel partner who in turn resells the subscription to the customer. Sales to channel partners are made at a discount and revenues are recorded at this discounted price over the subscription terms. The Company does not have any influence or specific knowledge of its partners' selling terms with their customers. See Note 13, "Segment Information and Information about Geographic Area" for disaggregation of revenue by geographic area.     NOTE 6. Acquisitions   On January 10, 2019, the Company acquired the assets of Adya, Inc. ("Adya"), an India-based company. The acquisition included a cloud application management platform, which enables security and compliance audits of SaaS applications.   Total purchase consideration was $ 1.0 million, including $ 0.2 million of deferred consideration due 18  months from the closing date of the acquisition, subject to potential adjustment from possible indemnity claims. During the three months ended September 30, 2020,  the $ 0.2 million of deferred consideration was fully paid to Adya.   The Company accounted for this transaction as a business combination and allocated $ 0.9 million of the purchase price to technology-based intangible assets and $ 0.1 million to goodwill. The acquired intangible assets relating to Adya's developed technology are being amortized over the estimated useful lives of approximately four years. Goodwill arising from the Adya acquisition is deductible for tax purposes over 15 years.    On July 24, 2020, the Company acquired certain intangible assets of Spell Security Private Limited ("Spell Security"), a privately held company incorporated in India. Spell Security’s technology expands the Company's endpoint behavior detection, threat hunting, malware research and multi-layered response capabilities for its EDR application. The purchase consideration related to the acquisition was $ 1.5 million in cash, including $ 0.2  million of deferred consideration due 15  months from the closing date of the acquisition, subject to potential adjustment from possible indemnity claims.   The Company accounted for this transaction as an asset purchase. The Company recognized intangible assets of $ 1.0 million for developed technology and $ 0.5 million for non-compete agreements, which will be amortized over four and two years, respectively.   18 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)       NOTE 7. Intangible Assets, Net   Intangible assets consist primarily of developed technology and patent licenses from 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:                   September 30, 2020             Weighted                               Weighted     Average                               Average Life     Remaining             Accumulated     Net Book   (in thousands, except for years)   (Years)     Life (Years)     Cost     Amortization     Value   Developed technology   4.6     2.1     $ 27,356     $ ( 14,593 )   $ 12,763   Patent licenses   14.0     3.9       1,387       ( 997 )   $ 390   Non-compete agreements   2.0     1.8       500       ( 42 )   $ 458   Total intangibles subject to amortization               $ 29,243     $ ( 15,632 )     13,611   Intangible assets not subject to amortization                                 40   Total intangible assets, net                               $ 13,651                     December 31, 2019             Weighted                               Weighted     Average                               Average Life     Remaining             Accumulated     Net Book   (in thousands, except for years)   (Years)     Life (Years)     Cost     Amortization     Value   Developed technology   4.6     2.7     $ 26,356     $ ( 10,066 )   $ 16,290   Patent licenses   14.0     4.7       1,387       ( 922 )     465   Total intangibles subject to amortization               $ 27,743     $ ( 10,988 )     16,755   Intangible assets not subject to amortization                                 40   Total intangible assets, net                               $ 16,795     Intangible asset amortization expense was $ 1.6  million and $ 1.5 million for the three months ended September 30, 2020 and 2019 , respectively, and $ 4.6  million for each of the nine months ended September 30, 2020 and 2019 .   As of September 30, 2020 , the Company expects amortization expense in future periods to be as follows:       Amortization Expense       (in thousands)   2020 (remaining three months)   $ 1,645   2021     6,581   2022     4,823   2023     350   2024     212   Total expected future amortization expense   $ 13,611     19 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   NOTE 8. Leases   On January 1, 2019, the Company adopted ASU No. 2016 - 02, “Leases (Topic 842 ),” which requires leases with durations greater than twelve months to be recognized on the balance sheet. We adopted the standard using the current period adjustment method with an effective date of January 1, 2019. For both operating and finance leases, we recognize a right-of-use asset, which represents our right to use the underlying asset for the lease term, and a lease liability, which represents the present value of our obligation to make payments arising over the lease term. The present value of the lease payments is calculated using the incremental borrowing rate for operating and finance leases. The incremental borrowing rate is determined using a portfolio approach based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term.   Where the Company is the lessee, the Company elected to account for non-lease components associated with its leases (e.g., common area maintenance costs) and lease components separately for substantially all of its asset classes, except for data centers, for which the Company elected to combine lease and non-lease components. In arrangements where the Company is the lessor, the Company elected to apply the practical expedient which allows the Company to account for lease components (e.g., customer premise equipment) and non-lease components (e.g., service revenue) as combined components under the revenue recognition guidance in Topic 606 as service revenues are the predominant components in the arrangements.   The Company leases property and equipment under finance and operating leases. For leases with terms greater than 12 months, the Company records the related asset and obligation at the present value of lease payments over the term. Many of its leases include rental escalation clauses, renewal options and/or termination options that are factored into our determination of lease payments when appropriate.   When available, the Company uses the rate implicit in the lease to discount lease payments to present value; however, most of the leases do not provide a readily determinable implicit rate. Therefore, the Company must estimate an incremental borrowing rate to discount the lease payments based on information available at lease commencement.   The table below presents the lease-related assets and liabilities recorded on the balance sheet.         September 30,     December 31,   (in thousands) Classification on the Balance Sheet   2020     2019   Assets                   Operating lease assets Operating lease - right of use asset   $ 47,985     $ 40,551   Finance lease assets Property and equipment, net     423       1,299   Total lease assets   $ 48,408     $ 41,850                       Liabilities                   Current                   Operating Operating lease liabilities, current   $ 11,777     $ 7,663   Finance Accrued liabilities     86       124   Noncurrent                   Operating Operating lease liabilities, noncurrent     48,392       44,015   Finance Other noncurrent liabilities     —       54   Total lease liabilities   $ 60,255     $ 51,856     20 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   The Company leases certain offices, computer equipment and its data center facilities under non-cancelable operating leases for varying periods through 2028. Lease expense was $ 4.6  million and $ 3.3  million for the three months ended September 30, 2020 and 2019 , respectively, and $ 13.5  million and $ 9.6  million for the nine months ended September 30, 2020 and 2019 , respectively.   Supplemental cash flow information related to operating leases was as follows:       Nine Months Ended       September 30,       2020     2019       (in thousands)   Cash payments included in the measurement of lease liabilities:                 Operating cash flows from operating leases   $ 9,183     $ 6,469   Lease liabilities arising from obtaining right-of-use assets:                 Operating leases   $ 15,735     $ 1,553     Operating and financing cash flows from finance leases were immaterial during the nine months ended September 30, 2020 and 2019 .   The weighted average remaining lease term and the weighted average discount rate of the Company's leases were as follows:       September 30, 2020     September 30, 2019   Weighted average remaining lease term (years)                 Operating leases     5.4       7.1   Finance leases     0.3       0.8   Weighted average discount rates                 Operating leases     4.8 %     4.6 % Finance leases     5.0 %     5.0 %     NOTE 9. Commitments and Contingencies   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.     NOTE 10. Stockholders' Equity and 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 15.7 million shares of common stock as of September 30, 2020 . 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, 2020 , 7.2 million shares were available for grant under the 2012 Plan.   21 Table of Contents   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 Company's initial public offering, and accordingly, no shares are currently available for grant under the 2000 Plan. The 2000 Plan continues to govern outstanding awards granted thereunder.   Stock-Based Compensation   The following table shows a summary of the stock-based compensation expense included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2020 and 2019 :       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands)   Cost of revenues   $ 770     $ 577     $ 1,967     $ 1,674   Research and development     3,197       2,831       9,887       7,875   Sales and marketing     1,227       1,459       4,300       3,590   General and administrative     5,295       3,516       13,776       12,024   Total stock-based compensation   $ 10,489     $ 8,383     $ 29,930     $ 25,163     As of September 30, 2020 , the Company h ad $ 16.6  million of total unrecognized stock-based compensation cost related to unvested options which was expected to be recognized over a weighted-average period of 2.2 years, and $ 54.1 million of unrecognized stock-based compensation cost related to unvested RSUs which was expected to be recognized over a weighted-average period of 2.4  years. Compensation cost is recognized over the service period. Forfeitures are estimated at the time of grant and revised in subsequent periods, if actual forfeitures differ from those estimates.   Stock Option Plan Activity   A summary of the Company’s stock option activity is as follows:                       Weighted                               Average                       Weighted     Remaining               Outstanding     Average     Contractual     Aggregate       Options     Exercise Price     Life (Years)     Intrinsic Value                             (in thousands)   Balance as of December 31, 2019     2,866,675     $ 40.54     6.0     $ 125,647   Granted     269,950     $ 107.01                 Exercised     ( 695,468 )   $ 34.46                 Canceled     ( 84,486 )   $ 86.08                 Balance as of September 30, 2020     2,356,671     $ 48.32     6.0     $ 120,055   Vested and expected to vest - September 30, 2020     2,208,860     $ 45.07     5.8     $ 118,883   Exercisable - September 30, 2020     1,666,292     $ 30.49     4.8     $ 112,502     22 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Restricted Stock   A summary of the Company’s RSU activity is as follows:               Weighted               Average Grant       Outstanding     Date Fair Value       RSUs     Per Share                     Balance as of December 31, 2019     1,214,818     $ 67.99   Granted     214,380     $ 106.72   Vested     ( 382,011 )   $ 61.84   Canceled     ( 194,576 )   $ 75.60   Balance as of September 30, 2020     852,611     $ 81.33   Outstanding and expected to vest - September 30, 2020     640,166     $ 79.28     Performance-Based Stock Options and Restricted Stock Units   On November 2, 2019, the Compensation Committee of the Company's board of directors granted the equity award for 2020, which consisted of time-based RSUs and performance-based non-statutory stock options ("NSOs"), to the Company’s Chairman and Chief Executive Officer, Philippe Courtot. The Compensation Committee, in consultation with its independent compensation consultant, designed these awards so that greater than 50% of this compensation was based on the achievement of performance goals linked to metrics designed to drive the creation of shareholder value.   The first portion of the award consists of 48,683 time-based RSUs that will vest in 16 quarterly installments beginning on December 1, 2019, assuming continued service through each applicable vesting date. The second portion of the award consists of 123,856 NSOs that will vest at the end of the performance period based on achievement of goals related to revenue growth and free cash flow per share growth during the three -year period from January 2020 through December 2022, generally conditioned on Mr. Courtot’s continued status as a service provider through the date that performance is certified. If Mr. Courtot’s employment (a) is terminated by reason of death or disability or (b) is terminated by the Company for reasons other than cause within 12 months following a change in control, then 100 % of any unvested portions of the award will vest, with any vesting in connection with change in control terminations conditioned upon the effectiveness of a release of claims in favor of the Company ( 2019 performance-based NSOs).   On December  21, 2018, the Compensation Committee granted the equity award for 2019, which consisted of time-based and performance-based RSUs, to Mr. Courtot. The Compensation Committee, in consultation with its independent compensation consultant, designed these awards so that greater than 50 % of this compensation was based on the achievement of performance goals linked to metrics designed to drive the creation of shareholder value.   The first portion of the award consists of 56,250 time-based RSUs that will vest in 16 quarterly increments beginning on January  1, 2019, assuming continued service through each applicable vesting date. The second portion of the award consists of 33,089 performance-based RSUs that will vest based on achievement of goals related to revenue growth for a three -year period from January 2019 through December 2021 and Adjusted EBITDA margin for the 2021 fiscal year, generally conditioned on Mr. Courtot’s continued status as a service provider through the date that performance is certified. The third portion of the award consists of 33,088 performance-based RSUs that will vest in three increments based on the achievement of goals related to revenue growth and Adjusted EBITDA margin for each of the 2019, 2020 and 2021 fiscal years, generally conditioned on Mr. Courtot’s continued status as a service provider through the date that performance is certified for the relevant increment. If Mr. Courtot’s employment (a) is terminated by reason of death or disability or (b) is terminated by the Company for reasons other than cause or good reason within 12 months following a change in control, then 100 % of any unvested portions of the award will vest, with any vesting in connection with change in control terminations conditioned upon the effectiveness of a release of claims in favor of the Company ( 2018 performance-based RSUs).   During the nine months ended September 30, 2020 , 14,864 shares, which represent 135 % of the target number of 11,030 shares under the 2018 performance-based RSUs, vested as a result of the Company achieving the performance goals for fiscal 2019 .   23 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   On June 10, 2020, the board of directors approved changes in the performance targets for the 2019 and 2018 performance-based awards. Based on the projected performance levels expected to be achieved for those awards as of June 10, 2020, the modification resulted in an incremental expense of $ 7.5  million, which is expected to be recognized over 12 quarters beginning with the quarter ended June 30, 2020. This amount may change based upon actual performance achieved and updates to estimates of future performance during the remainder of the performance periods. During the three and  nine months ended September 30, 2020 , $ 0.9 million and $ 1.1  million, respectively, of incremental expenses due to the modification were recognized.   During the three months ended September 30, 2020 and 2019 , stock-based compensation costs of $ 2.0  million, including changes due to modifications, and $ 0.2  million, respectively, were recognized for the performance-based NSOs and RSUs. During the nine months ended September 30, 2020 and 2019 , stock-based compensation costs of $ 2.8 million, including changes due to modifications, and $ 0.7  million, respectively, were recognized for the performance-based NSOs and RSUs.   Share Repurchase Program   On February 5, 2018, the Company's board of directors authorized a $ 100.0 million  two -year share repurchase program, which was announced on February 12, 2018. On October 30, 2018, October 30, 2019 and May 7, 2020, the Company announced that its board of directors had authorized an increase of $ 100.0 million, $ 100.0 million and $ 100.0 million, respectively, to the original share repurchase program authorization, resulting in an aggregate authorization of $ 400.0 million. Shares may be repurchased from time to time on the open market in accordance with Rule 10b - 18 of the Exchange Act of 1934, including pursuant to a pre-set trading plan adopted in accordance with Rule 10b5 - 1 under the Exchange Act ("Rule 10b5 - 1" ), until April 28, 2022.   Repurchased shares are retired and reclassified as authorized and unissued shares of common stock. On retirement of the repurchased shares, common stock is reduced by an amount equal to the number of shares being retired multiplied by the par value. The excess amount that is retired over its par value is first allocated as a reduction to additional paid-in capital based on the initial public offering price of the stock, with the remaining excess to retained earnings.   During the  nine months ended September 30, 2020 , the Company repurchased  940,750  shares of its common stock for approximately $ 91.9 million. All share repurchases were made using cash resources. As of September 30, 2020 , approximately $ 136.7 million remained available for share repurchases pursuant to the Company's share repurchase program.     NOTE 11. Net income Per Share   The computations for basic and diluted net income per share are as follows:       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands, except per share data)   Numerator:                                 Net income   $ 22,743     $ 19,174     $ 67,756     $ 48,672   Denominator:                                 Weighted-average shares used in computing net income per share:                                 Basic     39,238       39,014       39,171       39,099   Effect of potentially dilutive securities:                                 Common stock options     1,229       1,783       1,351       1,882   Restricted stock units     297       365       385       466   Diluted     40,764       41,162       40,907       41,447   Net income per share:                                 Basic   $ 0.58     $ 0.49     $ 1.73     $ 1.24   Diluted   $ 0.56     $ 0.47     $ 1.66     $ 1.17     24 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Potentially dilutive securities not included in the calculation of diluted net income per share because doing so would be anti-dilutive are as follows:       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands)   Common stock options     476       462       634       408   Restricted stock units     60       51       43       53         536       513       677       461       NOTE 12. Income Taxes   The Company's provision for income taxes for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company makes a cumulative adjustment in such period.   The Company's quarterly tax provision, and estimate of its annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income (or loss), the mix of jurisdictions to which such income relates, changes in how the Company does business, and tax law developments. The Company's estimated effective tax rate for the year differs from the U.S. statutory rate of 21% primarily due to non-deductible stock-based compensation expense, state taxes, and the benefit of U.S. federal income tax credits and foreign-derived intangible income deduction.   The Company recorded an income tax provision of $ 4.9  million and $ 5.2  million for the three months ended September 30, 2020 and 2019 , respectively, resulting in an effective tax rate of 17.7 % and 21.2 %, respectively. The tax provision for the three months ended September 30, 2020 as compared to the tax provision for the three months ended September 30, 2019 changed primarily due to higher excess tax benefits from stock-based compensation, offset by an increase in pre-tax income.   The Company recorded an income tax provision of $ 9.2  million and $ 10.0  million for the nine months ended September 30, 2020 and 2019 , respectively, resulting in an effective tax rate of 11.9 % and 17.1 %, respectively. The tax provision for the nine months ended September 30, 2020 as compared to the tax provision for the nine months ended September 30, 2019 changed primarily due to higher excess tax benefits from stock-based compensation, offset by an increase in pre-tax income.   As of September 30, 2020 , the Company had unrecognized tax benefits of $ 8.7  million, of which $ 4.4  million, if recognized, would favorably impact the Company's effective tax rate. As of December 31, 2019 , the Company had unrecognized tax benefits of $ 7.8 million, of which $ 4.2 million, if recognized, would favorably impact the Company's effective tax rate. The Company does not anticipate a material change in its unrecognized tax benefits in the next 12 months.   On June 29, 2020, the California governor signed into law the 2020 Budget Act, which temporarily suspends the utilization of net operating losses and limits the utilization of the research credit to $5 million annually for 2020, 2021 and 2022. The Company is continuing to assess the 2020 Budget Act, but currently does not expect any material impact to the condensed consolidated financial statements.     NOTE 13. Segment Information and Information about Geographic Area   The Company operates in one segment. The Company determines its reportable operating segments in accordance with the provisions in the FASB guidance on segment reporting, which establishes standards for, and requires disclosure of, certain financial information related to reportable operating segments and geographic regions. The Company’s chief operating decision maker is the Chairman and Chief Executive Officer, who makes operating decisions, assesses performance and allocates resources on a consolidated basis. The Company’s principal operating and decision-making functions are located in the United States.   25 Table of Contents   Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)   Revenue by geographic area, based on the customer's billing address, is as follows:       Three Months Ended     Nine Months Ended       September 30,     September 30,       2020     2019     2020     2019       (in thousands)   United States   $ 59,152     $ 53,132     $ 171,130     $ 152,457   Foreign     33,917       29,539       97,032       84,486   Total   $ 93,069     $ 82,671     $ 268,162     $ 236,943     Property and equipment, net, by geographic area, is as follows:       September 30,     December 31,       2020     2019       (in thousands)   United States   $ 47,014     $ 46,100   India     12,907       9,221   Foreign     7,653       5,258   Total property and equipment, net   $ 67,574     $ 60,579     26 Table of Contents