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QUALYS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with (1) our condensed consolidated financial statements (unaudited) and the related notes included elsewhere in this report, and (2) the audited consolidated financial statements and the related notes and management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission, or SEC, on February 28, 2014. In addition to historical information, this Quarterly Report on Form 10-Q contains "forward-looking" statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, it is possible to identify forward-looking statements because they contain words such as "anticipates," "believes," "contemplates," "continue," "could," "estimates," "expects," "future," "intends," "likely," "may," "plans," "potential," "predicts," "projects," "seek," "should," "target," or "will," or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about: • our financial performance, including our revenues, costs, expenditures, growth rates, operating expenses and ability to generate positive cash flow to attain and sustain profitability; • anticipated technology trends, such as the use of cloud solutions; • our ability to adapt to changing market conditions; • economic and financial conditions, including volatility in foreign exchange rates; • our ability to diversify our sources of revenues; • the effects of increased competition in our market; • our ability to effectively manage our growth; • our anticipated investments in sales and marketing, our infrastructure, new solutions, and research and development; • maintaining and expanding our relationships with channel partners; • our ability to maintain, protect and enhance our brand and intellectual property; • costs associated with defending intellectual property infringement and other claims; • our ability to attract and retain qualified employees and key personnel; • our ability to successfully enter new markets and manage our international expansion; and • other factors discussed in this Quarterly Report on Form 10-Q in the sections titled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. The results, events and circumstances reflected in these forward-looking statements are subject to risks, uncertainties, assumptions, and other factors including those described in Part II, Item 1A (Risk Factors) of this Quarterly Report and those discussed in other documents we file with the Securities and Exchange Commission. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements used herein. We cannot provide assurance that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements. Overview We are a pioneer and leading provider of cloud security and compliance solutions that enable organizations to identify security risks to their IT infrastructures, help protect their IT systems and applications from ever-evolving cyber attacks and achieve compliance with internal policies and external regulations. Our cloud solutions address the growing security and compliance complexities and risks that are amplified by the dissolving boundaries between internal and external IT infrastructures and web environments, the rapid adoption of cloud computing and the proliferation of geographically dispersed IT assets. Our integrated suite of security and compliance solutions delivered on our QualysGuard Cloud Platform enables our customers to identify their IT assets, collect and analyze large amounts of IT security data, discover and prioritize vulnerabilities, recommend remediation actions and verify 22-------------------------------------------------------------------------------- Table of Contents the implementation of such actions. Organizations use our integrated suite of solutions delivered on our QualysGuard Cloud Platform to cost-effectively obtain a unified view of their security and compliance posture across globally-distributed IT infrastructures. We were founded and incorporated in December 1999 with a vision of transforming the way organizations secure and protect their IT infrastructure and applications and initially launched our first cloud solution, QualysGuard Vulnerability Management, in 2000. This solution has provided the substantial majority of our revenues to date, representing 82% and 84% of total revenues for the nine months ended September 30, 2014 and 2013, respectively. As this solution gained acceptance, we introduced new solutions to help customers manage increasing IT security and compliance requirements. In 2006, we added our PCI Compliance solution, and in 2008, we added our Policy Compliance solution. In 2009, we broadened the scope of our cloud services by adding Web Application Scanning. We continued our expansion in 2010, launching Malware Detection Service and Qualys SECURE Seal for automated protection of websites. In 2012, we introduced our virtualized private cloud platform as an additional deployment option of our solutions for customers and partners. In 2014, we released a new Continuous Security Monitoring service for Internet-facing systems, which allows customers to continuously monitor their mission-critical assets and to be alerted to security vulnerabilities or misconfigurations that may make them susceptible to a cyber attack. We provide our solutions through a software-as-a-service model, primarily with renewable annual subscriptions. These subscriptions require customers to pay a fee in order to access our cloud solutions. We invoice our customers for the entire subscription amount at the start of the subscription term, and the invoiced amounts are treated as deferred revenues and are recognized ratably over the term of each subscription. We continue to experience significant revenue growth from existing customers as they renew and purchase additional subscriptions. We market and sell our solutions to enterprises, government entities and to small and medium-sized businesses across a broad range of industries, including education, financial services, government, healthcare, insurance, manufacturing, media, retail, technology and utilities. In the nine month periods ended September 30, 2014 and 2013, approximately 70% of our revenues were derived from customers in the United States. We sell our solutions to enterprises and government entities primarily through our field sales force and to small and medium-sized businesses through our inside sales force. We generate a significant portion of sales through our channel partners, including managed service providers, value-added resellers and consulting firms in the United States and internationally. We have had continued revenue growth in the nine months ended September 30, 2014 compared to the same period in 2013. Our revenues increased to $34.3 million in the three months ended September 30, 2014 from $27.7 million for the comparable period in 2013, representing an increase of $6.6 million or 24%. Revenues reached $97.0 million for the nine months ended September 30, 2014, compared to $78.9 million for the nine months ended September 30, 2013. For the three months ended September 30, 2014 and 2013, we had net income of $3.2 million and $1.3 million, respectively. For the nine months ended September 30, 2014 and 2013, we had net income of $4.5 million and $1.6 million, respectively. Adjusted EBITDA In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor Adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that Adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude in Adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that Adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry. Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. We calculate Adjusted EBITDA as net income before (1) other (income) 23-------------------------------------------------------------------------------- Table of Contents expense, net, which includes interest income, interest expense and other income and expense, (2) provision for income taxes, (3) depreciation and amortization of property and equipment, (4) amortization of intangible assets and (5) stock-based compensation. The following unaudited table presents the reconciliation of net income to Adjusted EBITDA for the three and nine months ended September 30, 2014 and 2013: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands, except percentages) Net income $ 3,208 $ 1,309 $ 4,474 $ 1,579 Other (income) expense, net 16 (24 ) (77 ) 134 Provision for income taxes 283 210 639 372 Depreciation and amortization of property and equipment 2,946 2,452 8,532 6,731 Amortization of intangible assets 98 105 294 319 Stock-based compensation 2,494 1,621 7,100 3,808 Adjusted EBITDA $ 9,045 $ 5,673 $ 20,962 $ 12,943 Percentage of revenues 26 % 20 % 22 % 16 % 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. GAAP. Some of these limitations are: • Adjusted EBITDA does not reflect certain cash and non-cash charges that are recurring; • Adjusted EBITDA does not reflect income tax payments that reduce cash available to us; • Adjusted EBITDA excludes depreciation and amortization of property and equipment and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future; and • Other companies, including companies in our industry, may calculate Adjusted EBITDA differently or not at all, which reduces their usefulness as a comparative measure. Because of these limitations, Adjusted EBITDA should be considered alongside other financial performance measures, including revenues, net income and our financial results presented in accordance with U.S. GAAP. 24-------------------------------------------------------------------------------- Table of Contents Key Components of Results of Operations Revenues We derive revenues from the sale of subscriptions to our security and compliance solutions, which are delivered on our cloud platform. We generate the substantial majority of our revenues through the sale of subscriptions to our QualysGuard Vulnerability Management solution, and we also have a growing number of customers who have purchased our additional solutions. Subscriptions to our solutions allow customers to access our cloud security and compliance solutions through a unified, web-based interface. Customers generally enter into one year renewable subscriptions. The subscription fee entitles the customer to an unlimited number of scans for a specified number of networked devices or web applications and, if requested by a customer as part of their subscription, a specified number of physical or virtual scanner appliances. Our physical and virtual scanner appliances are requested by certain customers as part of their subscriptions in order to scan IT infrastructures within their firewalls and do not function without, and are not sold separately from, subscriptions for our solutions. Customers are required to return physical scanner appliances if they do not renew their subscriptions. We typically invoice our customers for the entire subscription amount at the start of the subscription term. Invoiced amounts are reflected on our condensed consolidated balance sheet as accounts receivable or as cash when collected, and as deferred revenues until earned and recognized ratably over the subscription period. Accordingly, deferred revenues represents the amount billed to customers that has not yet been earned or recognized as revenues, pursuant to subscriptions entered into in current and prior periods. Cost of Revenues Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for employees who operate our data centers and provide support services to our customers. Other expenses include depreciation of data center equipment and physical scanner appliances and computer hardware provided to certain customers as part of their subscriptions, expenses related to the use of third-party data centers, amortization of third-party technology licensing fees and related maintenance support, fees paid to contractors who supplement or support our operations center personnel and overhead allocations. We expect to continue to make capital investments to expand and support our data center operations, which will increase the cost of revenues in absolute dollars. Operating Expenses Research and Development Research and development expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our research and development teams. Other expenses include third-party contractor fees, amortization of intangibles related to prior acquisitions and overhead allocations. All research and development costs are expensed as incurred. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as develop new solutions and capabilities and expect that research and development expenses will increase in absolute dollars. 25-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Sales and marketing expenses consist primarily of personnel expenses, comprised of salaries, benefits, sales commissions, performance-based compensation and stock-based compensation for our worldwide sales and marketing teams. Other expenses include marketing and promotional events, lead-generation marketing programs, public relations, travel and overhead allocations. All costs are expensed as incurred, including sales commissions. Sales commissions are expensed in the quarter in which the related order is received and are paid in the month subsequent to the end of that quarter, which results in increased expenses prior to the recognition of related revenues. Our new sales personnel are typically not immediately productive, and the resulting increase in sales and marketing expenses we incur when we add new personnel may not result in increased revenues if these new sales personnel fail to become productive. The timing of our hiring of sales personnel and the rate at which they generate incremental revenues may affect our future operating results. We expect to continue to invest in additional sales personnel and more marketing programs as we introduce new solutions on our platform, which will increase sales and marketing expenses in absolute dollars. General and Administrative General and administrative expenses consist primarily of personnel expenses, comprised of salaries, benefits, performance-based compensation and stock-based compensation, for our executive, finance and accounting, legal, human resources and internal information technology support teams, as well as professional services, insurance, fees, certain other corporate governance-related expenses, and overhead allocations. We expect that general and administrative expenses will increase in absolute dollars, as we continue to add personnel and incur professional services to support our growth and compliance requirements. Other Income (Expense), Net Our other income (expense), net consists primarily of interest and investment income from our short-term and long-term investments; foreign exchange gains and losses, the majority of which result from fluctuations between the U.S. dollar and the Euro, British pound and Japanese yen, and interest expense associated with our capital leases. Provision for Income Taxes Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by wholly-owned subsidiaries, along with state income taxes payable in the United States. The provision for income taxes also includes changes to unrecognized tax benefits related to uncertain tax positions. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the tax impact of timing differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the statutory rate change is enacted into law. We maintain a valuation allowance on our U.S. federal and state net deferred tax assets. Our cash tax expense is impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits. Given the valuation allowance and sensitivity of current cash taxes to local rules, our effective tax rate could fluctuate significantly on a quarterly basis, to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, and also due to changes in our earnings projections, by changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, or accounting principles, as well as certain discrete items. 26-------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables set forth selected condensed consolidated statements of operations data for each of the periods presented. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) Consolidated Statements of Operations Data: Revenues $ 34,348 $ 27,749 $ 97,006 $ 78,923 Cost of revenues (1) 7,421 6,415 21,442 18,134 Gross profit 26,927 21,334 75,564 60,789 Operating expenses: Research and development (1) 6,490 5,151 19,305 15,739 Sales and marketing (1) 11,774 10,411 36,111 30,739 General and administrative (1) 5,156 4,277 15,112 12,226 Total operating expenses 23,420 19,839 70,528 58,704 Income from operations 3,507 1,495 5,036 2,085 Other income (expense), net (16 ) 24 77 (134 ) Income before provision for income taxes 3,491 1,519 5,113 1,951 Provision for income taxes 283 210 639 372 Net income $ 3,208 $ 1,309 $ 4,474 $ 1,579 ____________________(1) Includes stock-based compensation as follows: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) Cost of revenues $ 175 $ 103 $ 482 $ 307 Research and development 599 253 1,551 697 Sales and marketing 561 363 1,852 804 General and administrative 1,159 902 3,215 2,000Total stock-based compensation $ 2,494 $ 1,621 $ 7,100 $ 3,808 27-------------------------------------------------------------------------------- Table of Contents The following table sets forth selected condensed consolidated statements of operations data for each of the periods presented as a percentage of revenues. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Revenues 100 % 100 % 100 % 100 % Cost of revenues 22 23 22 23 Gross profit 78 77 78 77 Operating expenses: Research and development 19 19 20 20 Sales and marketing 34 38 37 39 General and administrative 15 15 16 15 Total operating expenses 68 72 73 74 Income from operations 10 5 5 3 Other income (expense), net 0 0 0 0 Income before provision for income taxes 10 5 5 3 Provision for income taxes 1 0 1 1 Net income 9 % 5 % 4 % 2 % Comparison of Three Months Ended September 30, 2014 and 2013 Revenues Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Revenues $ 34,348 $ 27,749 $ 6,599 24 % Revenues increased $6.6 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to new customer subscriptions entered into after September 30, 2013 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $6.6 million, $4.7 million was from customers in the United States and the remaining $1.9 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions. 28-------------------------------------------------------------------------------- Table of Contents Cost of Revenues Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Cost of revenues $ 7,421 $ 6,415 $ 1,006 16 % Percentage of revenues 22 % 23 % Gross profit percentage 78 % 77 % Cost of revenues increased $1.0 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to a $0.4 million increase in depreciation expenses related to additional computer hardware and software for our new and existing data centers; increased consulting expenses of $0.3 million; increased third-party software maintenance expense of $0.1 million; as well as increased data center costs of $0.1 million, driven by expanded storage and other data center-related costs. Research and Development Expenses Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Research and development $ 6,490 $ 5,151 $ 1,339 26 % Percentage of revenues 19 % 19 % Research and development expenses increased $1.3 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to an increase in personnel expenses of $1.1 million, including higher stock-based compensation, principally driven by the addition of employees as we continue to invest in enhancing our platform and developing new solutions and capabilities; and higher corporate overhead costs of $0.2 million, principally due to expansion of our research and development team in India Sales and Marketing Expenses Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Sales and marketing $ 11,774 $ 10,411 $ 1,363 13 % Percentage of revenues 34 % 38 % Sales and marketing expenses increased $1.4 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to an increase in personnel expenses of $1.1 million, including higher commission expense and stock-based compensation, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts. We also incurred increased marketing expenses of $0.2 million, primarily related to increased trade show activities. 29-------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) General and administrative $ 5,156 $ 4,277 $ 879 21 % Percentage of revenues 15 % 15 % General and administrative expenses increased $0.9 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily driven by increased personnel expenses of $0.8 million, including higher employee stock-based compensation, principally due to the addition of employees to support the growth of our business; increased professional services of $0.1 million; and increased bad debt expense and other fees of $0.1 million, partially offset by lower non-employee stock-based compensation of $0.3 million relative to the same period a year ago. Other Income (Expense), Net Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Other income (expense), net $ (16 ) $ 24 $ (40 ) NM Percentage of revenues 0 % 0 % Other income (expense), net remained relatively constant during the three months ended September 30, 2014 compared to the three months ended September 30, 2013. Other income (expense) during the three months ended September 30, 2014 and 2013 consisted primarily of interest and investment income of $0.1 million, offset by foreign exchange losses of $0.1 million. Provision for Income Taxes Three Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Provision for income taxes $ 283 $ 210 $ 73 35 % Percentage of revenues 1 % 0 % Provision for income taxes increased $0.1 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The provision for income taxes is primarily for taxes on income in foreign jurisdictions and state income taxes in the United States. The increase is due to higher taxable income in foreign and state jurisdictions, primarily resulting from higher non-deductible stock-based compensation in the three months ended September 30, 2014. 30-------------------------------------------------------------------------------- Table of Contents Comparison of Nine Months Ended September 30, 2014 and 2013 Revenues Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Revenues $ 97,006 $ 78,923 $ 18,083 23 % Revenues increased $18.1 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to new customer subscriptions entered into after September 30, 2013 and from an increase in the purchase of subscriptions from existing customers. Of the total increase of $18.1 million, $12.8 million was from customers in the United States and the remaining $5.3 million was from customers in foreign countries. The growth in revenues reflects increased demand for our solutions. Cost of Revenues Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages)Cost of revenues $ 21,442 $ 18,134 $ 3,308 18 % Percentage of revenues 22 % 23 % Gross profit percentage 78 % 77 % Cost of revenues increased $3.3 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to a $1.5 million increase in depreciation expenses related to additional computer hardware and software for our new and existing data centers; increased consulting expenses of $0.6 million; increased personnel expenses of $0.6 million, principally driven by the addition of employees in our operations staff and higher stock-based compensation; and increased third-party software maintenance expense of $0.5 million. Research and Development Expenses Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Research and development $ 19,305 $ 15,739 $ 3,566 23 % Percentage of revenues 20 % 20 % Research and development expenses increased $3.6 million in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to an increase in personnel expenses of $2.7 million, including higher stock-based compensation, principally driven by the addition of employees as we continue to invest in enhancing our platform and developing new solutions and capabilities; higher corporate overhead costs of $0.4 million, principally due to expansion of our research and development team in India; and $0.2 million in consulting and professional service expenses. 31-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Sales and marketing $ 36,111 $ 30,739 $ 5,372 17 % Percentage of revenues 37 % 39 % Sales and marketing expenses increased $5.4 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to an increase in personnel expenses of $4.4 million, including higher commission expense and stock-based compensation, principally driven by the addition of employees as we continue to expand our domestic and international sales and marketing efforts. We also incurred increased marketing expenses of $0.8 million, primarily related to increased trade show and marketing program activities. General and Administrative Expenses Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) General and administrative $ 15,112 $ 12,226 $ 2,886 24 % Percentage of revenues 16 % 15 % General and administrative expenses increased $2.9 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily driven by increased personnel expenses of $2.1 million, including higher employee stock-based compensation, principally due to the addition of employees to support the growth of our business; increased professional services of $0.5 million; and increased bad debt expense and other fees of $0.3 million, partially offset by lower non-employee stock-based compensation of $0.3 million. Other Income (Expense), Net Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Other income (expense), net $ 77 $ (134 ) $ 211 NM Percentage of revenues 0 % 0 % Other income (expense), net increased $0.2 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase is primarily due to lower foreign currency exchange losses of $0.3 million and higher interest and investment income of $0.1 million. Additionally, in 2013, we received proceeds of $0.2 million from a negotiated settlement that was included in other income (expense) that did not recur in 2014. 32-------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes Nine Months Ended September 30, Change 2014 2013 $ % (in thousands, except percentages) Provision for income taxes $ 639 $ 372 $ 267 72 % Percentage of revenues 1 % 1 % Provision for income taxes increased $0.3 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The provision for income taxes is primarily for taxes on income in foreign jurisdictions and state income taxes in the United States. The increase is due to higher taxable income in foreign and state jurisdictions, primarily resulting from higher non-deductible stock-based compensation in the nine months ended September 30, 2014. Liquidity and Capital Resources At September 30, 2014, our principal source of liquidity was cash, cash equivalents, and short-term and long-term investments of $151.3 million, including $2.1 million held outside of the United States by our foreign subsidiaries. We do not anticipate that we will need funds generated from foreign operations to fund our domestic operations. However, if we repatriate these funds, we could be subject to U.S. income taxes on such amounts, less previously paid foreign income taxes. We have experienced positive cash flows from operations during the nine months ended September 30, 2014 and 2013. We believe our existing cash, cash equivalents, short-term and long-term investments, and cash from operations will be sufficient to fund our operations for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our spending on research and development efforts, international expansion and investment in data centers. We may also seek to invest in or acquire complementary businesses or technologies. Cash Flows The following summary of cash flows for the periods indicated has been derived from our condensed consolidated financial statements included elsewhere in this report: Nine Months Ended September 30, 2014 2013 (in thousands) Cash provided by operating activities $ 25,085 $ 15,191 Cash provided by (used in) investing activities 16,687 (10,415 ) Cash provided by financing activities 4,372 2,513 Effect of exchange rate changes on cash and cash equivalents (228 ) (56 ) Net increase in cash and cash equivalents $ 45,916 $ 7,233 33-------------------------------------------------------------------------------- Table of Contents Cash Flows from Operating Activities In the nine months ended September 30, 2014, cash flows from operating activities of $25.1 million resulted from our net income of approximately $4.5 million, as adjusted by an increase in deferred revenues of $6.9 million, attributable to our continued growth. These working capital increases are further increased by non-cash items including depreciation and amortization expense of $8.8 million and stock-based compensation expense of $7.1 million, partially offset by an increase in prepaid expenses and other assets of $1.2 million due to prepayment of certain maintenance contracts and an increase in accounts receivable of $2.0 million, due to the overall growth of our business. In the nine months ended September 30, 2013, cash flows from operating activities of $15.2 million resulted from our net income of approximately $1.6 million, as adjusted by an increase in deferred revenues of $4.7 million, attributable to our continued growth. These working capital increases are further increased by non-cash items including depreciation and amortization expense of $7.1 million and stock-based compensation expense of $3.8 million, partially offset by an increase in accounts receivable of $0.7 million, as well as a decrease of $1.5 million in accounts payable and accrued liabilities due to the timing of payments. Cash Flows from Investing Activities In the nine months ended September 30, 2014, investing activities provided $16.7 million primarily attributable to the maturity and sale of investments of $144.2 million, partially offset by the purchase of investments of $117.3 million and the use of $10.3 million of cash for capital expenditures, including computer hardware and software for our data centers to support our growth and development, and to purchase physical scanner appliances and computer hardware provided to certain customers as part of their subscriptions. In the nine months ended September 30, 2013, cash used in investing activities of $10.4 million was primarily attributable to $10.4 million of cash for capital expenditures, including computer hardware and software for our data centers to support our growth and development, and to purchase physical scanner appliances provided to certain customers as part of their subscriptions. There were also purchases of investments of $113.7 million, partially offset by sales and maturities of investments of $113.5 million. Cash Flows from Financing Activities In the nine months ended September 30, 2014, cash provided by financing activities of $4.4 million was primarily attributable to $5.0 million of proceeds from the exercise of stock options, partially offset by repayments on our capital lease obligations of $0.8 million. In the nine months ended September 30, 2013, cash provided by financing activities of $2.5 million was primarily attributable to $3.4 million of proceeds from the exercise of stock options, partially offset by repayments on our capital lease obligations of $0.9 million. 34-------------------------------------------------------------------------------- Table of Contents Contractual Obligations Our principal commitments consist of obligations under our outstanding leases for office space, third-party data centers and certain computer equipment. The following table summarizes our contractual cash obligations at September 30, 2014 and the effect such obligations are expected to have on our liquidity and cash flows in future periods: Payment Due by Period Remainder of 2019 and Contractual Obligations Total 2014 2015-2016 2017-2018 thereafter (in thousands) Operating lease obligations (1) $ 9,951 $ 1,049 $ 5,280 $ 2,273 $ 1,349 Total $ 9,951 $ 1,049 $ 5,280 $ 2,273 $ 1,349 (1) Operating lease obligations represent our obligations to make payments under the lease agreements for our facilities, data centers, and office equipment leases. During the nine months ended September 30, 2014, we made regular payments on our operating lease obligations of $3.3 million. Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. Recent Accounting Pronouncements See Note 1 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. We believe that of our significant accounting policies, which are described in the notes to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on February 28, 2014, the accounting policies related to revenue recognition, income taxes and stock-based compensation involve the greatest degree of judgment and complexity and have the greatest potential impact on our consolidated financial statements. A critical accounting policy is one that is material to the presentation of our consolidated financial statements and requires us to make difficult, subjective or complex judgments for uncertain matters that could have a material effect on our financial condition and results of operations. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. 35-------------------------------------------------------------------------------- Table of Contents |