What changed in this filing

/stocks — the workspaceLOADING

Item 7. Management’s Discussion and Analysis

2021-02-22 compared with 2020-02-21 · 102 added, 145 removed, 191 unchanged (56% of the section changed)

1 unchanged sentence

You should read the following discussion in conjunction with the section titled "Selected Consolidated Financial Data" and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.

You should carefully review and consider the information regarding our financial condition and results of operations set forth under Part I-Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 27, 2019, for an understanding of our results of operations and liquidity discussions and analysis comparing fiscal year 2018 to fiscal year 2017.

You should carefully review and consider the information regarding our financial condition and results of operations set forth under Part I-Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 21, 2020, for an understanding of our results of operations and liquidity discussions and analysis comparing fiscal year 2019 to fiscal year 2018.

In addition to historical information, this discussion contains forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially from our expectations, as discussed in "Forward-Looking Statements" in Part I of this Annual Report on Form 10-K.

Factors that could cause such differences include, but are not limited to, those described in the section titled "Risk Factors" and elsewhere in this Annual Report on Form 10-K.

We are a pioneer and leading provider of a cloud-based platform delivering IT, security and compliance solutions that enable organizations to identify security risks to their information technology (IT) infrastructures, help protect their IT systems and applications from ever-evolving cyber-attacks and achieve compliance with internal policies and external regulations.

We are a pioneer and leading provider of a cloud-based platform delivering IT, security and compliance solutions that enable organizations to identify security risks to their information technology (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, containers and serverless IT models, and the proliferation of geographically dispersed IT assets.

5 unchanged sentences

These Cloud Apps address and include:

• IT Security:

Vulnerability Management (VM), Threat Protection (TP), Continuous Monitoring (CM), Patch Management (PM), Indication of Compromise (IOC);

• Compliance Monitoring:

Policy Compliance (PC), PCI Compliance (PCI), File Integrity Monitoring (FIM), Security Configuration Assessment (SCA), Security Assessment Questionnaire (SAQ), Out of-Band Configuration Assessment (OCA);

Vulnerability Management (VM), Vulnerability Management, Detection and Response (VMDR), Threat Protection (TP), Continuous Monitoring (CM), Patch Management (PM), Multi-Vector Endpoint Detection and Response (EDR), Indication of Compromise (IOC), Certificate Assessment (CRA);

Policy Compliance (PC), Security Configuration Assessment (SCA), PCI Compliance (PCI), File Integrity Monitoring (FIM), Security Assessment Questionnaire (SAQ), Out of-Band Configuration Assessment (OCA);

Web Application Security:

Web Application Scanning (WAS), Web Application Firewall (WAF);

• Global IT Asset Management:

Asset Management:

Global IT Asset Inventory (AI), CMDB Sync (SYN), Certificate Inventory (CRI);

Cloud/Container Security:

Cloud Inventory (CI), Cloud Security Assessment (CSA), Container Security

Our VM solutions (including VM, CM, TP, Cloud Agent for VM, allocated scanner revenue and Qualys Private Cloud Platform) have provided a majority of our revenues to date , representing 73% of total revenue in 2019 and 74% of total revenues in each of 2018 and 2017 , respectively.

Cloud Inventory (CI), Cloud Security Assessment (CSA), Container Security (CS).

We provide our solutions through a software-as-a-service model, primarily with renewable annual subscriptions.

1 unchanged sentence

We generally 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 our existing customers as they renew and purchase additional subscriptions .

We continue to experience revenue growth from our existing customers as they renew and purchase additional subscriptions.

We market and sell our solutions to enterprises, government entities and small and medium-sized businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities.

As of December 31, 2019 , we had over 15,700 active customers in more than 133 countries, including a majority of each of the Forbes Global 100 and Fortune 100.

In 2020, 2019 and 2018, approximately 63%, 64% and 67%, respectively, of our revenues were derived from customers in the United States based on our customers billing address.

1 unchanged sentence

We generate a significant portion of sales through our channel partners, including managed service providers, value-added resellers and consulting firms in the United States and internationally.

We have had continued revenue growth over the past three years.

Our revenues reached $321.6 million in 2019 from $278.9 million in 2018 and $230.8 million in 2017, respectively, representing period-over-period increases of $42.7 million and $48.1 million in 2019 and 2018, or 15% and 21%, respectively.

We generated net income of $69.3 million in 2019, $57.3 million in 2018 and $40.4 million in 2017.

Impacts of COVID-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic.

As a result of COVID-19, we have modified certain aspects of our business, including restricting employee travel, requiring employees to work from home, and canceling certain events and meetings, among other modifications.

We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders.

COVID-19 has not had and is not expected to have a significant impact on our business in 2021.

However, while we have not incurred significant disruptions from the COVID-19 outbreak, we are 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 our customers and partners.

We will continue to evaluate the nature and extent of the impact to our business, financial position, results of operations and cash flows.

Key Components of Results of Operations

3 unchanged sentences

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 Qualys Cloud Platform into our customers' private cloud environment.

4 unchanged sentences

Cost of Revenues

Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits, amortization of internal-use software, 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, amortization of intangibles related to acquisitions, maintenance support, fees paid to contractors who supplement or support our operations center personnel and overhead allocations.

Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits, amortization of capitalized internal-use software, 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 software and license fees, amortization of intangibles related to acquisitions, maintenance support, fees paid to contractors who supplement or support our operations center personnel and overhead allocations.

We expect to continue to make capital investments to expand and support our data center operations, which will increase the cost of revenues in absolute dollars.

2 unchanged sentences

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, software and license fees, amortization of intangibles related to acquisitions and overhead allocations.

We capitalize certain research and development costs related to new products' internal-use software development efforts.

Capitalized costs include salaries, benefits, and stock-based compensation charges for employees that are directly involved in developing new products for our cloud security platform during the application development stage.

Capitalized costs related to internally developed software under development are treated as construction in progress until the program, feature or functionality is ready for its intended use, at which time amortization commences.

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.

Other expenses include third-party contractor fees, software and license fees, amortization of intangibles related to acquisitions and overhead allocations.

Sales and Marketing

3 unchanged sentences

We amortize the capitalized commission cost as a selling expense on a straight-line basis over a period of five years.

We expense sales commissions related to contract renewals.

We expense sales commissions related to contract renewals as incurred.

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.

2 unchanged sentences

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 and human resources teams, as well as professional services, fees, software licenses and overhead allocations.

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, IT, legal and human resources teams, as well as professional services, fees, software licenses 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.

2 unchanged sentences

foreign exchange gains and losses, the majority of which result from fluctuations between the U.S.

Dollar and the Euro, British Pound (GBP) and Indian Rupee;

and losses on disposal of property and equipment.

Dollar and the Euro, British Pound ("GBP") and Indian Rupee ("INR");

and gains and losses from disposal of property and equipment.

Provision for Income Taxes

2 unchanged sentences

activities are subject to income taxes in the local countries at rates which were generally similar to the U.S.

statutory tax rate.

Our effective rate differs from the U.S.

statutory rate primarily due to excess tax benefits related to stock-based compensation, U.S.

federal research and development tax credits, U.S.

foreign tax credits, and non-deductible compensation to certain employees.

statutory tax rate. 

Income taxes are accounted for under the asset and liability method.

4 unchanged sentences

This assessment requires judgment as to the likelihood and amounts of future taxable income.

Our income tax expense in 2019 increased due to an increase in our income before income taxes, as well as a reduction in excess stock-based compensation deductions.

Results of Operations

10 unchanged sentences

Income before income taxes

Provision for (benefit from) income taxes

Provision for income taxes

Comparison of Years Ended December 31, 2020 and 2019

1 unchanged sentence

Revenues increased $41.4 million in 2020 compared to 2019 due to an increase in the subscriptions from existing customers and new customer subscriptions entered into in 2020.

Revenues from customers existing at or prior to December 31, 2018 grew by $31.2 million to $310.1 million during 2019.

Revenues from customers existing at or prior to December 31, 2019 grew by $31.0 million to $352.6 million during 2020.

Subscriptions from new customers added in 2020 contributed $10.4 million to the increase in revenues.

7 unchanged sentences

Gross profit percentage

C ost of revenues increased $3.3 million in 2019 compared to 2018 , primarily due to an increase of $2.4 million in amortization expense related to acquired technologies resulting from our business acquisitions;

increased costs related to our data centers of $1.9 million;

and increased third-party software license costs of $1.2 million resulting from our continued

business growth.

These increases were partially offset by a $1.8 million decrease in stock-based compensation and personnel expenses driven by a higher proportion of employees in lower-cost locations and a $0.5 million decrease in depreciation expenses.

Cost of revenues increased $9.7 million in 2020 compared to 2019.

The increase was primarily due to an increase in personnel costs of $3.5 million driven by the headcount increase to support the growth of our business, an increase in licenses and software services of $1.9 million, an increase in data center costs of $1.8 million to meet growing demand, an increase in equipment repairs and maintenance costs of $1.2 million and a $1.3 million increase in depreciation of property and plant and allocation of increased leasing expenses to the cost of revenue related to our new office in India and data centers. 

Research and Development Expenses

2 unchanged sentences

Percentage of revenues

Res earch and development expenses increased $15.0 million in 2019 compared to 2018 , primarily due to an increase in personnel expenses of $7.4 million, driven by additional employees hired to support the growth of our business;

an increase in stock-based compensation expense of $3.2 million;

an increase in allocation of overhead costs to the research and development department of $3.2 million;

and an increase in compensation costs associated with prior acquisitions of $2.7 million, offset by a $1.4 million reversal of acquisition-related obligations previously recorded.

Research and development expenses increased $4.3 million in 2020 compared to 2019, primarily due to an increase in personnel expense of $3.2 million driven by additional employees hired to support the growth of our business, a $2.0 million increase in allocation of overhead costs to the research and development department mainly caused by an increase in leasing expenses for our new office in India, an increase in depreciation and amortization expense of $0.8 million and an increase in licenses and software services of $0.4 million.

These increases were partially offset by a decrease in acquisition-related expense of $2.1 million.

Sales and Marketing Expenses

2 unchanged sentences

Percentage of revenues

Sales and marketing expe nses increased $0.8 million in 2019 compared to 2018 , primarily due to an increase in personnel expenses of $4.4 million, driven by additional employees hired to support the growth of our business, and an increase in trade shows and travel related costs of $1.0 million.

These increases were offset by a decrease in compensation costs associated with prior acquisitions of $1.8 million;

a decrease of $0.8 million in allocated overhead costs due to a lower proportion of sales and marketing employees in the employee base;

a decrease of $0.8 million in consulting fees;

a decrease of $0.7 million in customer acquisition costs;

and a decrease of $0.4 million in recruiting and training costs.

Sales and marketing expenses decreased $2.9 million in 2020 compared to 2019, primarily due to decreases in trade show related costs of $4.5 million, travel related expenses of $3.0 million and other marketing related expenses of $0.8 million driven by the COVID-19 pandemic, partially offset by an increase in personnel costs of $4.7 million due to additional employees hired to support the growth of our business and a $0.7 million increase in commission expenses.

General and Administrative Expenses

2 unchanged sentences

Percentage of revenues

General and administrative expenses increase d $1.7 million in 2019 compared to 2018 , primarily driven by an increase in stock-based compensation of $1.5 million, driven by additional employees hired to support growth of business, and an increase in personnel related expenses of $1.1 million, which were partially offset by a decrease of $1.1 million in consulting fees and temporary employee costs.

General and administrative expenses increased $5.8 million in 2020 compared to 2019, primarily due to an increase in legal fees of $3.4 million due to legal and compliance matters and a $1.1 million increase in personnel costs due to additional employees hired to support the growth of our business and an increase in performance-based stock compensation of $1.8 million as a result of the modification of certain awards in June 2020 and a higher forecasted performance level, partially offset by a decrease in office supply expense of $0.5 million due to working from home during the COVID-19 pandemic.

Total Other Income (Expense), Net

2 unchanged sentences

Percentage of revenues

Total other income (expense), net, increased $2.6 million in 2019 compared to 2018 , primarily due to an increase in interest income from marketable securities due to higher yields and larger portfolio of investments.

Total other income (expense), net, decreased $2.3 million in 2020 compared to 2019, primarily due to a decrease in interest income driven by lower yield.

Provision for (benefit from) Income Taxes

(in thousands, except percentages)

Provision for (benefit from) income taxes

Provision for income taxes

Percentage of revenues

We recorded an income tax expense of $10.6 million in 2019 as compared to an income tax benefit of $(1.8) million in 2018 .

Our income tax expense increased in 2019 by $12.5 million due to an increase in our income before income taxes, as well as a reduction in the income tax benefits from excess stock-based compensation deductions.

Our income tax expense decreased in 2020 compared to 2019 by $0.2 million primarily due to an increase in income tax benefit from excess stock-based compensation deductions offset by the increase in income before income taxes.

Key Non-GAAP Metric

10 unchanged sentences

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S.

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 (benefit from) income taxes, (3) depreciation of property and equipment, (4) amortization of intangible assets, (5) stock-based compensation, (6) non-recurring expenses and (7) cash acquisition-related expense that do not reflect ongoing costs of operating the business.

The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for each of the periods presented.

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 (benefit from) income taxes, (3) depreciation of property and equipment, (4) amortization of intangible assets, (5) stock-based compensation and (6) non-recurring expenses that do not reflect ongoing costs of operating the business.

Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation from or as a substitute for the measures presented in accordance with U.S.

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

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

Because of these limitations, Adjusted EBITDA 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.

The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for the years ended December 31, 2020 and 2019.

Year Ended December 31,

2 unchanged sentences

Amortization of intangible assets

Provision for (benefit from) income taxes

Provision for income taxes

Stock-based compensation

Other income (expense), net

Acquisition-related expense (1)

Adjusted EBITDA

Percentage of revenues

(1) Relates to compensation expense from the acquisition of Adya, NetWatcher and Layered Insight.

Limitations of Adjusted EBITDA

Adjusted EBITDA, a non-GAAP financial measure, has limitations as an analytical tool, and should not be considered in isolation from or as a substitute for the measures presented in accordance with U.S.

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

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

Liquidity and Capital Resources

At December 31, 2019 , our principal source of liquidity was cash, cash equivalents and short-term and long-term investments of $418.4 million , including $24.6 million of cash held outside of the United States by our foreign subsidiaries.

December 31, 2020, our principal source of liquidity was cash, cash equivalents and marketable securities of $454.5 million, including $30.7 million of cash held outside of the United States.

We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations.

However, if we repatriate these funds, we could be subject to foreign withholding taxes.

We have experienced positive cash flows from operations during the years ended December 31, 2019 and 2018 .

We believe our existing cash, cash equivalents, short-term and long-term marketable securities, and cash from operations will be sufficient to fund our operations for at least the next twelve months.

In 2020, we expect capital expenditures to be in a ran ge of $30.0 million to $35.0 million , which includes approximately $5.0 million of capital expenditures at our new offices in Pune, India.

We generated positive cash flows from operations during the years ended

December 31, 2020 and

We believe our existing cash, cash equivalents, marketable securities and cash from operations will be sufficient to fund our operations for at least the next twel

In 2021, we expect capital expenditures to be in a range of $30.0 million to $35.0 million.

Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing, type and extent of our spending on research and development efforts, international expansion and investment in data centers.

We may also seek to invest in or acquire complementary businesses or technologies.

We may also seek to invest in or acquire complementary businesses or technologies. While the COVID-19 pandemic has not had a material adverse financial impact on our operations to date, the future impact of the pandemic cannot be predicted with certainty and may increase our costs of capital and otherwise adversely affect our business, result of operations, financial condition and liquidity.

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

6 unchanged sentences

Cash Flows from Operating Activities

In 2019 , cash provided by operating activities of $160.6 million was primarily due to $69.3 million of net income, as adjusted by increases in non-cash items including stock-based compensation expense of $34.9 million , depreciation and amortization expense of $31.2 million, an increase in deferred income taxes of $7.1 million;

and an increase in deferred revenues of $28.1 million due to our continued growth in sales.

In 2020, cash provided by operating activities of $180.1 million was primarily due to $91.6 million of net income, as adjusted for non-cash items including stock-based compensation expense of $40.0 million, depreciation and amortization expense of $32.8 million, deferred income tax expense of $3.5 million, an increase in accrued liabilities of $5.1 million due to higher compensation related accrual as well as timing of payments and an increase in deferred revenues of $30.9 million due to our continued growth in sales.

These increases were partially offset by a $22.6 million increase in accounts receivable due to higher billings.

In 2019, cash provided by operating activities of $160.6 million was primarily due to $69.3 million of net income, as adjusted by increases in non-cash items including stock-based compensation expense of $34.9 million, depreciation and amortization expense of $31.2 million, an increase in deferred income taxes of $7.1 million;

and an increase in deferred revenues of $28.1 million due to our continued growth in sales.

These increases were partially offset by $6.0 million of increased prepayments primarily for computer hardware maintenance fees;

a $2.5 million decrease in accounts receivable due to higher billings;

a $2.5 million increase in accounts receivable due to higher billings;

and a $1.1 million decrease in accounts payable mainly due to timing of payments.

In 2018, cash provided by operating activities of $125.5 million was primarily due to $57.3 million of net income, as adjusted by increases in non-cash items including stock-based compensation expense of $30.1 million and depreciation and amortization expense of $28.9 million.

There was also an increase in deferred revenues of $24.7 million which was attributable to our continued growth in sales and a $4.9 million increase in accounts payable and accrued liabilities due to more expenditures to support growing our business and higher accruals related to acquisitions in 2018.

These increases were partially offset by a $11.5 million decrease in accounts receivable due to timing of customer payments and a $5.0 million decrease related to prepaid assets due to timing.

Cash Flows from Investing Activities

In 2019 , cash used in investing activities of $35.0 million was primarily attributable to $27.6 million of cash used for capital expenditures, $4.1 million in aggregate payments made in connection with our acquisitions of Adya and holdback payments for our acquisitions in the prior years, net purchases of investments of $2.8 million, and $0.6 million for our purchase of an investment in a privately-held company.

In 2020, cash used in investing activities of $80.9 million was primarily attributable to $49.8 million of cash used for purchases of marketable securities, net of sales and maturities, and $29.6 million of cash used for capital expenditures mainly related to computer equipment to support our growth and development, net of proceeds received from disposal of certain assets.

Additionally, we paid $1.5 million in connection with our acquisition of the assets of Spell Security and payment of deferred consideration to Adya. 

In 2019, cash used in investing activities of $35.0 million was primarily attributable to $27.6 million of cash used for capital expenditures, $4.1 million in aggregate payments made in connection with our acquisitions of Adya and holdback payments for our acquisitions in the prior years, net purchases of investments of $2.8 million, and $0.6 million for our purchase of an investment in a privately-held company.

The $27.6 million increase in capital expenditures included leasehold improvements for a new office in India and computer hardware purchases to support our growth.

In 2018, cash used in investing activities of $93.5 million was primarily attributable to net purchases of investments of $54.6 million and $22.8 million of cash used for capital expenditures, including computer hardware and software for our data centers to support our growth, and $13.6 million used in connection with our acquisition of Layered Insight and the assets of 1Mobility in addition to $2.5 million for our purchase of an investment in a privately-held company.

Cash Flows from Financing Activities

In 2019 , cash used in financing activities of $79.0 million was primarily attributable to $86.4 million of common stock repurchases and $15.7 million of payments related to net share settlement of equity awards, offset by $24.8 million of proceeds from the exercise of stock options.

In 2018, cash used in financing activities of $77.5 million was primarily attributable to $85.0 million of common stock repurchases and $14.9 million of payments related to net share settlement of equity awards, offset by $24.1 million of proceeds from the exercise of stock options.

In 2020, cash used in financing activities of $112.6 million was primarily attributable to $126.7 million of common stock repurchases and $20.2 million of payments related to net share settlement of equity awards, offset by $34.5 million of proceeds from the exercise of stock options.

In 2019, cash used in financing activities of $79.0 million was primarily attributable to $86.4 million of common stock repurchases and $15.7 million of payments related to net share settlement of equity awards, offset by $24.8 million of proceeds from the exercise of stock options.

Contractual Obligations

Our principal commitments consist of obligations under our outstanding leases for office space, third-party data centers and office equipment.

The following table summarizes our contractual cash obligations at December 31, 2019 and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

Our principal commitments consist of obligations under our outstanding leases for office space and third-party data centers.

The following table summarizes our contractual cash obligations at December 31, 2020 and the effect such obligations are expected to have on our liquidity and cash flows in future periods: 

Payment Due by Period

Contractual Obligations:

Less Than 1 Year

More than 5 Years

2 unchanged sentences

Purchase order obligations

Operating lease obligations represent our obligations to make payments under the lease agreements for our facilities, data centers, and office equipment leases.

During the year ended December 31, 2019, total payments for our operating lease obligations was $9.4 million.

Operating lease obligations primarily represent our obligations to make payments under the lease agreements for our facilities and data centers.

During the year ended December 31, 2020, total payments for our operating lease obligations was $13.4 million.

Off-Balance Sheet Arrangements

3 unchanged sentences

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S.

Our consolidated financial statements are prepared in accordance with U.S. GAAP.

The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures.

6 unchanged sentences

Revenue Recognition

We derive revenues from the sale of subscriptions to our security and compliance solutions, which are delivered on our cloud platform.

Subscriptions to our solutions allow customers to access our cloud-based security and compliance solutions through a unified, web-based interface.

Customers generally enter into one-year renewable subscriptions though some customers do enter into subscriptions with longer terms.

In some limited cases, we also provide certain computer equipment used to extend our Qualys 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 recognize revenues on a usage basis for certain other limited scan arrangements, where expiration dates can be extended.

Physical equipment (scanners and private cloud platforms) are accounted for as operating leases under ASC 842.

The company used the practical expedient to combine lease and nonlease components as a combined component under ASC 606 due to the software subscription nonlease components being the predominant component of the combined component.

Therefore, the Company recognizes revenue for the physical equipment ratably over the related subscription period.

Costs of shipping and handling charges associated with physical scanner appliances and other computer equipment are included in cost of revenues.

Deferred r evenues consist of customer contracts billed or cash received that will be recognized in the future under subscriptions existing at the balance sheet date.

We adopted ASC 606, "Revenue from Contracts with Customers" with a date of initial application of January 1, 2018.

We adopted ASC 606 using the modified retrospective method and recognized the cumulative effect as an adjustment to the opening balance of equity at January 1, 2018.

We previously expensed sales commission as incurred.

Under ASC 606, sales commissions cost related to new business and upsells are recorded as an asset.

We amortize the capitalized commission cost as a selling expense on a straight-line basis over a period of five years.

Five years represents the estimated life of the customer relationship taking into account factors such as peer estimates of technology lives and customer lives as well as our own historical data.

Applying the practical expedient in ASC 340-40-25-4, we expense commissions related to renewals with a contract term of one year or less.

The current and noncurrent portions of deferred commissions are included in prepaid expenses and other current assets, and other noncurrent assets, respectively, in our consolidated balance sheets.

We derive revenues from subscriptions that require customers to pay a fee in order to access our cloud solutions.

Contract period with customers generally ranges from less than a year to five years.  The subscription fee entitles the customer to an unlimited number of scans for a specified number of networked devices or web applications and, if requested by a customer as part of their subscription, a specified number of physical or virtual scanner appliances. Our physical and virtual scanner appliances are requested by certain customers as part of their subscriptions in order to scan IT infrastructures within their firewalls and do not function without, and are not sold separately from, subscriptions for our solutions.

In some limited cases, we also provide certain computer equipment used to extend our Qualys 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. 

In accordance with ASC 606 Revenue from Contracts with Customers ("ASC 606"), revenue is recognized when control of the subscription service is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services.

Our subscription services are typically satisfied ratably over the subscription term as our cloud-based offerings are delivered to customers electronically and over time.

In addition, we recognize revenues for certain limited scan arrangements on an as-used basis.

We recognize revenue related to professional services based on time and materials or completion of milestones stated in the contracts. When physical equipment are provided to the customers as part of the subscription service contract, we apply the practical expedient allowed under ASC 842 Leases to combine lease and nonlease components as a combined component to be accounted for under ASC 606, as we determined that the software subscription is the predominant component of the combined components. Therefore, we recognize revenue for the physical equipment ratably over the related subscription period. 

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.

We elected the practical expedient to expense commissions on renewals where the specific anticipated contract term amortization period is one year or less.

We amortize the capitalized commission cost as a selling expense on a straight-line basis over a period of five years.

We are subject to income taxes in the United States as well as other tax jurisdictions in which we conduct business.

1 unchanged sentence

activities are subject to local income tax and may also be subject to U.S.

Income tax expense or benefit is recognized for the amount of taxes payable or refundable for the current year, and for deferred tax assets and liabilities for the tax consequences of events that have been recognized in an entity’s financial statements or tax returns.

We must make significant assumptions, judgments and estimates to determine our current provision for (benefit from) income taxes, our deferred tax assets and liabilities, and any valuation allowance to be recorded against our deferred tax assets.

7 unchanged sentences

The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which the strength of the evidence can be objectively verified.

Based on the analysis of positive and negative factors noted above, we do not have a valuation allowance against U.S.

federal and certain state deferred tax assets.

We believe it is more likely than not that our California deferred tax assets will not be realized because the income attributed to California is not expected to be sufficient to recognize these deferred tax assets.

Based on the analysis of positive and negative factors noted above, we believe it is more likely than not that our California deferred tax assets will not be realized because the income attributed to California is not expected to be sufficient to recognize these deferred tax assets.

Accordingly, we continue to record a valuation allowance as of December 31, 2020 for our California deferred tax assets.

If, in the future, we determine that these deferred tax assets are more likely than not to be realized, a release of all or part, of the related valuation allowance could result in an income tax benefit in the period such determination is made.

W e do not have a valuation allowance against U.S.

federal and certain other state deferred tax assets.

We recognize an income tax expense or benefit with respect to uncertain tax positions in our financial statements that we judge is more likely than not to be sustained solely on its technical merits in a tax audit, including resolution of any related appeals or litigation processes.

To make this judgment, we must interpret complex and sometimes ambiguous tax laws, regulations and administrative practices.

If an income tax position meets the more likely than not recognition threshold, then we must measure the amount of the tax benefit to be recognized by determining the largest amount of tax benefit that has a greater than a 50% likelihood of being realized upon effective settlement with a taxing authority that has full knowledge of

all of the relevant facts.

It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible settlement outcomes.

2 unchanged sentences

These judgments are difficult because a taxing authority may change its behavior as a result of our disclosures in our financial statements.

We must reevaluate our income tax positions on a quarterly basis to consider factors such as changes in facts or circumstances, effectively settled issues under audit, the potential for interest and penalties, and new audit activity.

We must reevaluate our income tax positions on a quarterly basis to consider factors such as changes in facts or circumstances, changes in tax laws, effectively settled issues under audit, the potential for interest and penalties, and new audit activity.

Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision.

On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law.

The new legislation contains several key tax provisions that impacted us, including the reduction of the corporate income tax rate from 35% to 21% effective January 1, 2018.

The new legislation also includes a variety of other changes, such as a one-time repatriation tax on accumulated foreign earnings (transition tax), acceleration of business asset expensing, and a reduction in the amount of executive pay that could qualify as a tax deduction, among others.

We recognized a provisional income tax expense of $10.4 million in the fourth quarter of 2017, from the re-measurement of certain deferred tax assets and liabilities as a result of the reduction of the federal tax rate, which was included as a component of the income tax provision on our consolidated statement of income.

We completed our analysis of the impacts of the 2017 Tax Act in the fourth quarter of 2018 with no material change to our provisional estimate.

Stock-Based Compensation

1 unchanged sentence

The fair value of each option is estimated on date of grant using the Black-Scholes-Merton option pricing model and the fair value of each restricted stock unit is based on the fair value of our 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.

Forfeitures are estimated on the date of grant and revised if actual or expected forfeiture activity differs materially from original estimates. For performance-based non-qualified stock options and restricted stock units, we recognize compensation costs when it is probable that the performance conditions will be met.

We assess these conditions on a quarterly basis.

Determining the appropriate fair value model and calculating the fair value of employee stock options requires the use of highly subjective assumptions, including the expected life of the stock option and stock price volatility.

The assumptions used in calculating the fair value of employee stock options represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management’s judgment.

As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

For performance-based non-qualified stock options and restricted stock units, we recognize compensation costs when it is probable that the performance conditions will be met.

We assess these conditions on a quarterly basis.

Fair Value Measurement

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

We measure and report 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.

For certain of our financial instruments, including cash and certain cash equivalents, accounts receivable, accounts payable and accrued liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these balances.

We measure and report certain cash equivalents, marketable securities 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.

Our financial instruments consist of assets measured using Level 1 and 2 inputs.

Level 1 assets include a highly liquid money market fund, which is valued using unadjusted quoted prices that are available in an active market for an identical asset.

Level 2 assets include fixed-income U.S.

government agency securities, commercial paper, corporate bonds, 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.

The carrying amounts of other financial instruments including accounts receivable, the investments in a privately-held company, account payables, accrued liabilities in our consolidated balance sheets approximates fair value as of December 31, 2019 and 2018.

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, including quoted prices for identical assets or liabilities in less active or inactive markets, quoted prices for similar assets or liabilities in active markets, or inputs other than quoted prices that are observable 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.

For further details, see Part II, Item 8 of this Annual Report on Form10-K Note 2, Fair Value of Financial Instruments.

Derivative Financial Instruments

Derivative financial instruments are utilized by us to reduce foreign currency exchange risks.

We use foreign currency forward contracts to mitigate the impact of foreign currency fluctuations of certain non-U.S.

dollar denominated asset positions, to date primarily cash and accounts receivable (non-designated), as well as to manage foreign currency fluctuation risk related to forecasted transactions (designated).

We account for these instruments as either non-designated or cash flow hedges, respectively.

Open contracts are recorded within prepaid expenses and other current assets, other noncurrent assets, accrued liabilities or other noncurrent liabilities in the consolidated balance sheets.

Gains and losses resulting from currency exchange rate movements on non-designated forward contracts are recognized in other income (expense).

Any gains or losses from derivatives designated as cash flow hedges are first accumulated in accumulated other comprehensive income (AOCI) and then reclassified to revenue when the hedged item impacts the consolidated financial statements.

We lease offices, our data center facilities and certain computer equipment under non-cancelable operating leases and finance leases.

On January 1, 2019, we adopted ASC 842 Leases 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. Many of our leases include rental escalation clauses, renewal options and/or termination options that are factored into our determination of lease payments and lease terms when appropriate.

The present value of the lease payments is calculated using the incremental borrowing rate of the underlying leases determined at lease commencement.

As most of our leases do not provide a readily determinable implicit rate, we determine an incremental borrowing rate 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 as the leases. 

Where we are the lessee, we elect to account for non-lease components associated with our leases (e.g., common area maintenance costs) and lease components separately for substantially all of our asset classes, except for data centers, for which we elected to combine lease and non-lease components.

For leases with a term of one year or less, we have elected not to record the right-of-use asset or liability.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis