QUALYS, INC. 10-Q

Item 1. Financial Statements Qualys, Inc. CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except share and per share data) June 30, 2020 December 31, 2019 Assets Current assets: Cash and cash equivalents $ 113,909 $ 87,559 Short-term marketable securities 233,922 211,331 Accounts receivable, net of allowance of $643 and $585 as of June 30, 2020 and December 31, 2019, respectively 75,938 78,034 Prepaid expenses and other current assets 24,338 18,692 Total current assets 448,107 395,616 Long-term marketable securities 97,483 119,508 Property and equipment, net 63,098 60,579 Operating leases - right of use asset 42,930 40,551 Deferred tax assets, net 16,971 18,830 Intangible assets, net 13,755 16,795 Goodwill 7,447 7,447 Restricted cash 1,200 1,200 Other noncurrent assets 16,024 15,082 Total assets $ 707,015 $ 675,608 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 1,395 $ 848 Accrued liabilities 24,810 22,784 Deferred revenues, current 199,732 192,172 Operating lease liabilities, current 9,161 7,663 Total current liabilities 235,098 223,467 Deferred revenues, noncurrent 19,070 20,935 Operating lease liabilities, noncurrent 45,050 44,015 Other noncurrent liabilities 23 388 Total liabilities 299,241 288,805 Commitments and contingencies (Note 9) Stockholders’ equity: Preferred stock, $0.001 par value; 20,000,000 shares authorized, no shares issued and outstanding at June 30, 2020 and December 31, 2019 — — Common stock, $0.001 par value; 1,000,000,000 shares authorized; 39,315,337 and 39,146,272 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively 39 39 Additional paid-in capital 384,202 362,408 Accumulated other comprehensive income 2,435 1,162 Retained earnings 21,098 23,194 Total stockholders’ equity 407,774 386,803 Total liabilities and stockholders’ equity $ 707,015 $ 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 Six Months Ended June 30, June 30, 2020 2019 2020 2019 Revenues $ 88,830 $ 78,929 $ 175,093 $ 154,272 Cost of revenues 18,891 17,537 37,386 35,246 Gross profit 69,939 61,392 137,707 119,026 Operating expenses: Research and development 18,058 17,695 36,041 33,532 Sales and marketing 15,783 17,165 34,013 34,480 General and administrative 10,590 10,424 21,714 20,855 Total operating expenses 44,431 45,284 91,768 88,867 Income from operations 25,508 16,108 45,939 30,159 Other income (expense), net: Interest expense — ( 28 ) ( 3 ) ( 70 ) Interest income 1,392 2,198 3,316 4,249 Other income, net 194 231 59 8 Total other income, net 1,586 2,401 3,372 4,187 Income before income taxes 27,094 18,509 49,311 34,346 Provision for income taxes 775 2,277 4,298 4,848 Net income $ 26,319 $ 16,232 $ 45,013 $ 29,498 Net income per share: Basic $ 0.67 $ 0.41 $ 1.15 $ 0.75 Diluted $ 0.64 $ 0.39 $ 1.10 $ 0.71 Weighted average shares used in computing net income per share: Basic 39,161 39,198 39,137 39,143 Diluted 40,919 41,530 40,928 41,570 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 Six Months Ended June 30, June 30, 2020 2019 2020 2019 Net income $ 26,319 $ 16,232 $ 45,013 $ 29,498 Other comprehensive income (loss): Available-for-sale debt securities: Changes in net unrealized gains, net of tax effects of ($324) and ($213) in the three months ended June 30, 2020 and 2019, respectively, and ($428) and ($251) in the six months ended June 30, 2020 and 2019, respectively. 1,093 724 1,444 1,379 Reclassification adjustments for net realized (gains) losses included in net income, net of tax effects of $5 and ($4) in the three months ended June 30, 2020 and 2019, respectively, and $30 and ($6) in the six months ended June 30, 2020 and 2019, respectively. ( 15 ) 15 ( 100 ) 43 Total changes in unrealized gains on marketable securities, net of tax 1,078 739 1,344 1,422 Cash flow hedges: Changes in net unrealized gains (losses), net of tax effects of $33 and ($43) in the three months ended June 30, 2020 and 2019, respectively, and ($61) and ($91) in the six months ended June 30, 2020 and 2019, respectively. ( 108 ) 148 208 351 Reclassification adjustments for net realized (gains) losses included in net income, net of tax effects of $25 and ($13) in the three months ended June 30, 2020 and 2019, respectively, and $82 and ($16) in the six months ended June 30, 2020 and 2019, respectively. ( 88 ) 43 ( 279 ) 53 Total changes in unrealized gains (losses) on cash flow hedges, net of tax ( 196 ) 191 ( 71 ) 404 Other comprehensive income, net of tax 882 930 1,273 1,826 Comprehensive income $ 27,201 $ 17,162 $ 46,286 $ 31,324 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) Six Months Ended June 30, 2020 2019 Cash flow from operating activities: Net income $ 45,013 $ 29,498 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense 15,633 15,809 Loss on disposal of property and equipment — 183 Bad debt expense 299 86 Stock-based compensation 19,441 16,780 Accretion of discounts on marketable securities ( 21 ) ( 1,060 ) Deferred income taxes 1,269 3,047 Changes in operating assets and liabilities: Accounts receivable 1,797 12,555 Prepaid expenses and other assets ( 6,725 ) ( 6,896 ) Accounts payable 220 ( 1,189 ) Accrued liabilities ( 972 ) ( 85 ) Deferred revenues 5,695 12,397 Other noncurrent liabilities — 150 Net cash provided by operating activities 81,649 81,275 Cash flow from investing activities: Purchases of marketable securities ( 162,912 ) ( 184,829 ) Sales and maturities of marketable securities 164,109 193,270 Purchases of property and equipment ( 11,568 ) ( 14,138 ) Business combinations — ( 1,850 ) Net cash used in investing activities ( 10,371 ) ( 7,547 ) Cash flow from financing activities: Repurchases of common stock ( 54,182 ) ( 24,117 ) Proceeds from exercise of stock options 20,430 8,991 Payments for taxes related to net share settlement of equity awards ( 11,115 ) ( 7,411 ) Principal payments under finance lease obligations ( 61 ) ( 836 ) Net cash used in financing activities ( 44,928 ) ( 23,373 ) Net increase in cash, cash equivalents and restricted cash 26,350 50,355 Cash, cash equivalents and restricted cash at beginning of period 88,759 42,226 Cash, cash equivalents and restricted cash at end of period $ 115,109 $ 92,581 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) Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income Retained Earnings Total Stockholders’ Equity Shares Amount 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 7 Table of Contents Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders’ Equity Shares Amount 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 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 six months ended June 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 9 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) income taxes. Actual results could differ from those estimates and such differences may be material to the accompanying unaudited condensed consolidated financial statements. 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 June 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, 10 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) 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 adjustme nt, 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. 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 (Continued) (unaudited ) The Company's Level 1 assets include a 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 usi ng 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 June 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: June 30, 2020 Amortized Cost Unrealized Gains Unrealized (Losses) Fair Value (in thousands) Cash and cash equivalents: Cash $ 106,272 $ — $ — $ 106,272 Money market funds 5,638 — — 5,638 Commercial paper 1,999 — — 1,999 Total 113,909 — — 113,909 Short-term marketable securities: Commercial paper 1,847 2 — 1,849 Corporate bonds 24,289 227 — 24,516 Asset-backed securities 6,511 52 — 6,563 U.S. government agencies 200,419 580 ( 5 ) 200,994 Total 233,066 861 ( 5 ) 233,922 Long-term marketable securities: Asset-backed securities 35,441 407 — 35,848 U.S. government agencies 14,544 444 — 14,988 Foreign government agencies 1,005 34 — 1,039 Corporate bonds 44,542 1,066 — 45,608 Total 95,532 1,951 — 97,483 Total $ 442,507 $ 2,812 $ ( 5 ) $ 445,314 12 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) December 31, 2019 Amortized Cost Unrealized Gains Unrealized (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 There were no marketable securities that had been in a continuous unrealized loss position for 12 months or longer. As of June 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: June 30, 2020 Level 1 Level 2 Fair Value (in thousands) Money market funds $ 5,638 $ — $ 5,638 Commercial paper — 3,848 3,848 U.S. government agencies — 215,982 215,982 Foreign government agencies — 1,039 1,039 Corporate bonds — 70,124 70,124 Asset-backed securities — 42,411 42,411 Total $ 5,638 $ 333,404 $ 339,042 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. 13 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) The following summarizes the fair value of marketable securities by contractual or effective maturity as of June 30, 2020 and December 31, 2019: June 30, 2020 Mature within One Year Mature after One Year through Two Years Mature over Two Years Fair Value (in thousands) Commercial paper $ 3,848 $ — $ — $ 3,848 U.S. government agencies 200,994 14,988 — 215,982 Foreign government agencies — — 1,039 1,039 Corporate bonds 24,516 24,506 21,102 70,124 Asset-backed securities 6,563 18,270 17,578 42,411 Total $ 235,921 $ 57,764 $ 39,719 $ 333,404 December 31, 2019 Mature within One Year Mature after One Year through Two Years Mature over 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 . U nrealized 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 June 30, 2020, the Company had 39 open designated cash flow hedge contracts with notional amounts of € 21.8 million, £ 9.2 million and Rs. 1,590 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 operation for the three and six months ended June 30, 2020 and 2019: 14 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) Three Months Ended June 30, Six Months Ended June 30, Derivative instruments designated as cash flow hedges: 2020 2019 2020 2019 Net unrealized (losses) gains recognized in AOCI: (in thousands) Foreign currency forward contracts (GBP, Euro and INR) $ ( 141 ) $ 191 $ 269 $ 442 Net unrealized (gains) losses reclassified from AOCI into income: Foreign currency forward contracts (GBP and Euro) ( 328 ) 56 ( 576 ) 69 Foreign currency forward contracts (INR) 215 — 215 — Net change in AOCI before tax $ ( 254 ) $ 247 $ ( 92 ) $ 511 As of June 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 gain of $ 0.9 million (before tax). As of June 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 loss of $ 0.6 million (before tax). Non-designated forward contracts At June 30, 2020, the Company had 15 outstanding non-designated forward contracts with notional amounts of € 12.5 million, £ 7.9 million and Rs. 351.7 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 June 30, 2020 and December 31, 2019: June 30, December 31, 2020 2019 Assets: (in thousands) Foreign currency forward contracts designated as cash flow hedge $ 453 $ 427 Foreign currency forward contracts not designated as hedging instruments 409 515 Total $ 862 $ 942 Liabilities: Foreign currency forward contracts designated as cash flow hedge $ ( 802 ) $ ( 524 ) Foreign currency forward contracts not designated as hedging instruments ( 309 ) ( 550 ) Total $ ( 1,111 ) $ ( 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 statement of operations: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) Net (losses) gains from non-designated forward contracts $ ( 224 ) $ 44 $ 580 $ 66 Other foreign currency transactions gains (losses) 475 249 ( 396 ) 66 Total foreign exchange gains, net 251 293 184 132 Other expenses ( 57 ) ( 62 ) ( 125 ) ( 125 ) Other income, net $ 194 $ 231 $ 59 $ 8 NOTE 3. Accumulated Other Comprehensive Income The components and changes in accumulated other comprehensive income, net of taxes, for the six months ended June 30, 2020 and 2019 were as follows: 15 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) Unrealized gains (losses) on AFS debt securities Unrealized gains (losses) on cash flow hedges Total (in thousands) Balances as of December 31, 2019 $ 822 $ 340 $ 1,162 Other comprehensive income before reclassification 1,444 208 1,652 Reclassification of gains from Other comprehensive income ( 100 ) ( 279 ) ( 379 ) Total change in unrealized gains (losses), net of tax 1,344 ( 71 ) 1,273 Balances as of June 30, 2020 $ 2,166 $ 269 $ 2,435 Unrealized gains (losses) on AFS debt securities Unrealized gains (losses) on cash flow hedges Total (in thousands) Balances as of December 31, 2018 $ ( 545 ) $ ( 41 ) $ ( 586 ) Other comprehensive income before reclassification 1,379 351 1,730 Reclassification of losses from Other comprehensive income 43 53 96 Total change in unrealized gains, net of tax 1,422 404 1,826 Balances as of June 30, 2019 $ 877 $ 363 $ 1,240 NOTE 4. Property and Equipment, Net Property and equipment, net, which includes assets under finance lease, consists of the following: June 30, December 31, 2020 2019 (in thousands) Computer equipment $ 124,021 $ 112,599 Computer software 26,241 26,137 Furniture, fixtures and equipment 8,140 6,973 Finance leases - right of use asset 3,503 3,503 Scanner appliances 16,366 15,864 Leasehold improvements 20,311 18,817 Total property and equipment 198,582 183,893 Less: accumulated depreciation and amortization ( 135,484 ) ( 123,314 ) Property and equipment, net $ 63,098 $ 60,579 Physical scanner appliances and other computer equipment had a net carrying value of $ 8.2 million and $ 4.9 million at June 30, 2020 and December 31, 2019, respectively, including assets that had not been placed in service of $ 4.5 million and $ 0.9 million, respectively. Depreciation and amortization expense relating to property and equipment, including assets under finance leases, was $ 6.4 million and $ 6.3 million for the three months ended June 30, 2020 and 2019, respectively, and $ 12.6 million and $ 12.8 million for the six months ended June 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. 16 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) 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. 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: June 30, 2020 December 31, 2019 (in thousands) Commission asset, current $ 2,968 $ 2,568 Commission asset, noncurrent $ 6,604 $ 6,454 For the three months ended June 30, 2020 and 2019, the Company recognized $ 0.7 million and $ 0.5 million, respectively, of commission expense from amortization of its commission assets. For the six months ended June 30, 2020 and 2019, the Company recognized $ 1.4 million and $ 0.9 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 $ 55.9 million and $ 49.1 million was recognized during the three months ended June 30, 2020 and 2019, respectively, which amounts were included in the deferred revenue balances as of December 31, 2019 and 2018, respectively. Revenue of $ 129.7 million and $ 113.3 million was recognized during the six months ended June 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 June 30, 2020: 17 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) Total Expected Revenue (in thousands) 2020 (remaining six months) $ 46,130 2021 62,693 2022 34,525 2023 8,533 2024 610 2025 and thereafter 184 Total $ 152,675 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 Six Months Ended June 30, June 30, 2020 2019 2020 2019 (in thousands) Direct $ 51,805 $ 45,672 $ 101,810 $ 88,711 Partner 37,025 33,257 73,283 65,561 Total $ 88,830 $ 78,929 $ 175,093 $ 154,272 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 eighteen months from the closing date of the acquisition, subject to potential adjustment from possible indemnity claims. Pro 18 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) forma financial information for this acquisition has not been presented because it is not material to the Company's condensed consolidated financial statements. 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 fifteen months from the closing date of the acquisition, subject to potential adjustment from possible indemnity claims. 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: June 30, 2020 (in thousands, except for years) Weighted Average Life (Years) Weighted Average Remaining Life (Years) Cost Accumulated Amortization Net Book Value Developed technology 4.6 2.2 $ 26,356 $ ( 13,056 ) $ 13,300 Patent licenses 14.0 4.2 1,387 ( 972 ) 415 Total intangibles subject to amortization $ 27,743 $ ( 14,028 ) 13,715 Intangible assets not subject to amortization 40 Total intangible assets, net $ 13,755 December 31, 2019 (in thousands, except for years) Weighted Average Life (Years) Weighted Average Remaining Life (Years) Cost Accumulated Amortization Net Book 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 wa s $ 1.5 million for each of the three months ended June 30, 2020 and 2019, and $ 3.0 million for each of the six months ended June 30, 2020 and 2019. 19 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) As of June 30, 2020 , the Company expects amortization expense in future periods to be as follows: Amortization Expense (in thousands) 2020 (remaining six months) $ 3,041 2021 6,081 2022 4,427 2023 100 2024 66 Total expected future amortization expense $ 13,715 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. 20 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) The table below presents the lease-related assets and liabilities recorded on the balance sheet. June 30, December 31, (in thousands) Classification on the Balance Sheet 2020 2019 Assets Operating lease assets Operating lease - right of use asset $ 42,930 $ 40,551 Finance lease assets Property and equipment, net 715 1,299 Total lease assets $ 43,645 $ 41,850 Liabilities Current Operating Operating lease liabilities, current $ 9,161 $ 7,663 Finance Accrued liabilities 117 124 Noncurrent Operating Operating lease liabilities, noncurrent 45,050 44,015 Finance Other noncurrent liabilities — 54 Total lease liabilities $ 54,328 $ 51,856 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 $ 4.5 million and $ 3.4 million for the three months ended June 30, 2020 and 2019, respectively, and $ 8.9 million and $ 6.4 million for the six months ended June 30, 2020 and 2019, respectively. Supplemental cash flow information related to operating leases was as follows: Six Months Ended June 30, 2020 June 30, 2019 (in thousands) Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 5,106 $ 4,200 Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 7,033 $ 1,525 Operating and financing cash flows from finance leases were immaterial during the six months ended June 30, 2020. The weighted average remaining lease term and the weighted average discount rate of the Company's leases were as follows: June 30, 2020 June 30, 2019 Weighted average remaining lease term (years) Operating leases 5.9 7.2 Finance leases 0.5 1.1 Weighted average discount rates Operating leases 4.9 % 4.6 % Finance leases 5.0 % 5.0 % 21 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) 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 June 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 June 30, 2020, 7.2 million shares were available for grant under the 2012 Plan. 2000 Equity Incentive Plan Under the 2000 Equity Incentive Plan (the "2000 Plan"), the Company was authorized to grant to eligible participants either ISOs or NSOs. The 2000 Plan was terminated in connection with the closing of the 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 six months ended June 30, 2020 and 2019: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (in thousands) Cost of revenues $ 583 $ 552 $ 1,197 $ 1,097 Research and development 3,253 2,704 6,690 5,044 Sales and marketing 1,513 1,063 3,073 2,131 General and administrative 4,095 4,016 8,481 8,508 Total stock-based compensation $ 9,444 $ 8,335 $ 19,441 $ 16,780 As of June 30, 2020 , the Company had $ 16.7 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 $ 54.3 million of unrecognized stock-based compensation cost related to unvested RSUs which was expected to be recognized over a weighted-average period of 2.5 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. 22 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) Stock Option Plan Activity A summary of the Company’s stock option activity is as follows: Outstanding Options Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Aggregate Intrinsic Value (in thousands) Balance as of December 31, 2019 2,866,675 $ 40.54 6.0 $ 125,647 Granted 155,300 $ 96.20 Exercised ( 593,045 ) $ 34.45 Canceled ( 26,083 ) $ 82.61 Balance as of June 30, 2020 2,402,847 $ 45.19 5.9 $ 141,415 Vested and expected to vest - June 30, 2020 2,246,671 $ 42.27 5.8 $ 138,778 Exercisable - June 30, 2020 1,704,504 $ 29.13 4.9 $ 127,656 Restricted Stock A summary of the Company’s RSU activity is as follows: Outstanding RSUs Weighted Average Grant Date Fair Value Per Share Balance as of December 31, 2019 1,214,818 $ 67.99 Granted 124,633 $ 95.96 Vested ( 284,603 ) $ 61.04 Canceled ( 154,670 ) $ 71.00 Balance as of June 30, 2020 900,178 $ 75.99 Outstanding and expected to vest - June 30, 2020 668,594 $ 74.20 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 23 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) 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 six months ended June 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. 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 current projected performance levels expected to be achieved for those awards, the modification resulted in an incremental expense of $ 7.5 million, which is expected to be recognized over 12 quarters. This amount may change based upon actual performance achieved and updates to estimates of future performance during the remainder of the performance periods. The modifications did not have a material impact on the condensed consolidated statement of operations for the three or six months ended June 30, 2020. During the three months ended June 30, 2020 and 2019, stock-based compensation costs of $ 0.5 million, including changes due to modifications, and $ 0.3 million, respectively, were recognized for the performance-based NSOs and RSUs. During the six months ended June 30, 2020 and 2019, stock-based compensation costs of $ 0.6 million, including changes due to modifications, and $ 0.5 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 six months ended June 30, 2020, the Company repurchased 588,750 shares of its common stock for approximately $ 54.2 million. All share repurchases were made using cash resources. As of June 30, 2020, approximately $ 174.4 million remained available for share repurchases pursuant to the Company's share repurchase program. 24 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) NOTE 11. Net income Per Share The computations for basic and diluted net income per share are as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands, except per share data) Numerator: Net income $ 26,319 $ 16,232 $ 45,013 $ 29,498 Denominator: Weighted-average shares used in computing net income per share: Basic 39,161 39,198 39,137 39,143 Effect of potentially dilutive securities: Common stock options 1,382 1,890 1,410 1,950 Restricted stock units 376 442 381 477 Diluted 40,919 41,530 40,928 41,570 Net income per share: Basic $ 0.67 $ 0.41 $ 1.15 $ 0.75 Diluted $ 0.64 $ 0.39 $ 1.10 $ 0.71 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 June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) Common stock options 452 419 585 381 Restricted stock units 2 54 18 62 454 473 603 443 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 $ 0.8 million and $ 2.3 million for the three months ended June 30, 2020 and 2019, respectively, resulting in an effective tax rate of 2.9 % and 12.3 %, respectively. The tax provision for the three months ended June 30, 2020 as compared to the tax provision for the three months ended June 30, 2019 changed primarily due to higher excess tax benefits from stock-based compensation in the current period. The Company recorded an income tax provision of $ 4.3 million and $ 4.8 million for the six months ended June 30, 2020 and 2019, respectively, resulting in an effective tax rate of 8.7 % and 14.1 %, respectively. The tax provision for the six months ended June 30, 2020 as compared to the tax provision for the six months ended June 30, 2019 changed primarily due to higher excess tax benefits from stock-based compensation in the current period. 25 Table of Contents Qualys, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited ) As of June 30, 2020 , the Company had unrecognized tax bene fits of $ 8.4 million, of which $ 4.2 million , if recognized, would favorably impact the Company's effective ta x 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 mate rial 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. Revenue by geographic area, based on the customer's billing address, is as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) United States $ 57,015 $ 50,704 $ 111,978 $ 99,325 Foreign 31,815 28,225 63,115 54,947 Total $ 88,830 $ 78,929 $ 175,093 $ 154,272 Property and equipment, net, by geographic area, is as follows: June 30, December 31, 2020 2019 (in thousands) United States $ 46,283 $ 46,100 India 11,255 9,221 Foreign 5,560 5,258 Total property and equipment, net $ 63,098 $ 60,579 26 Table of Contents